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    Question

    At point A, inflation is equal to the underlying rate of

    inflation and output is at the level of output consistent with the equilibrium unemployment rate. If the economy were at point B, you would expect
    A the underlying rate of inflation to accelerate because the actual inflation rate exceeds the underlying rate of inflation Correct Answer Incorrect Answer
    B prices will decline because there is an excess supply of goods (neoclassical assumption) Correct Answer Incorrect Answer
    C output to decline because there is an excess supply of goods (Keynesian assumption) Correct Answer Incorrect Answer
    D consumer spending to decline because goods are more expensive Correct Answer Incorrect Answer

    Solution

    When we are not at the equilibrium rate of unemployment, the rate of underlying inflation changes. Since we don't know what aggregate demand is doing, we can't meaningfully speak of excess supply or demand. Our presumption will be that aggregate demand and short-run aggregate supply are equal.

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