1 more Economics Q

The economy is currently operating at full employment, but government policymakers find the prevailing rate of unemployment politically unacceptable. They decide to pursue an expansionary fiscal policy to reduce that rate of unemployment. If the public fully anticipates the effects of this decision, what is the most likely outcome of that policy choice? a) Real GDP and employment will increase, price level will remain unchanged b) Real GDP and employment will increase temporarily, but will return to their original levels along with a higher price in the long term. c) The only short and long run effects will be a higher price with no change in employment or real GDP d) Price level will increase. Real GDP and employment will increase in the short and long run. Answer is: C I got B, can anyone explain this to me? Thanks!

The change is some kind of tax cut or refund. Anticipated future cash increases the immediate demand for cash. That is, employees will anticipate the real wage increase and spend the extra cash. Thus the supply of labor won’t change. I hope that’s correct.

That may well be right Isura but there’s a way easier way of looking at this quesiton… Unemployment has three components: Cyclical structural and frictional. At full employment cyclical unemployment=0 Therefore in this example there is both frictional and structural unemployment. If you read the definitions of these two types of unemployment you will realize that an increase in expansionary fiscal policy does not effect them. It only effects cyclical unemployment which is unemployment as a result of business cycles. THEREFORE. With a basic understanding of the forms of unemployment one would realize that an expansionary fiscal policy would not reduce unemployment and automatically jump to C.

ok that makes sense. so youre saying, because it is already at “full employment” (no cyclical unemployment) … any expansionary policy will not change employment levels. if it was below full employment to start, employment would increase along with price levels?

You got er

C since the affects of expansionary policy are fully anticipated so the Real GDP and employment quantity of labor would remain the same, but the price level will rise. All in accord with CFAI econ book!! I am not a big fan of economics. No matter how much you study, its still insufficient

Could not agree more…