Question

According to Phelps, if unemployment falls below the equilibrium level, inflation tends to ________ of inflation ________ . Which of the following describes the outcome? a. No lower unemployment, but higher inflation b. Lower unemployment and no higher inflation c. Lower unemployment and lower Inflation d. Lower unemployment and higher inflation

Answer 1

If unemployment falls below the equilibrium level, inflation tends to rise, resulting in lower unemployment and higher inflation.

Step-by-step explanation:

The correct answer is d. Lower unemployment and higher inflation.

According to Phelps, if unemployment falls below the equilibrium level, inflation tends to rise. This is because as the unemployment rate decreases, workers have more bargaining power to demand higher wages, which leads to increased production costs for firms. In order to cover these higher costs, firms often raise their prices, resulting in inflation.

For example, if the unemployment rate falls below the equilibrium level of 4% to 2%, inflationary pressure may occur as workers demand higher wages. As a result, the economy experiences both lower unemployment and higher inflation concurrently.