Session:13 The Neoclassical Perspective
Answer Key
Principles of Macroeconomics 3e | Leadership Development – Micro-Learning Session
Rice University 2020 | Michael Laverty, Colorado State University Global Chris Littel, North Carolina State University| https://openstax.org/details/books/principles-macroeconomics-3e
2. An unemployment rate of zero percent is presumably well below the rate that is consistent with potential GDP and with the natural rate of unemployment. As a result, this policy would be attempting to push AD out to the right.
In the short run, it is possible to have unemployment slightly below the natural rate for a time, at a price of higher inflation, as shown by the movement from E0 to E1 along the short-run AS curve. However, over time the extremely low unemployment rates will tend to cause wages to be bid up, and shift the short-run AS curve back to the left. The result would be a higher price level, but an economy still at potential GDP and the natural rate of unemployment, as determined by the long-run AS curve. If the government continues this policy, it will continually be pushing the price level higher and higher, but it will not be able to achieve its goal of zero percent unemployment, because that goal is inconsistent with market forces.