An economy is at potential GDP. If the price level increases in the short-run, all else equal, then... Select one: a. Firms will realize greater profits, since revenues increase, but nominal wages are still fixed. As a result, real GDP will rise above its full employment level, and the unemployment rate will be below the natural rate of unemployment. b. Firms will realize reduced profits since revenues fall, but nominal wages are still fixed. As a result, Real GDP falls below its full employment level, and the unemployment rate will be below the natural rate of unemployment. c. Firms will realize greater profits, since revenues increase, but nominal wage costs are falling. As a result, Real GDP rises beyond its full employment level, and the unemployment rate will be above the natural rate of unemployment. d. None of the above

a. Firms will realize greater profits, since revenues increase, but nominal wages are still fixed. As a result, real GDP will rise above its full employment level, and the unemployment rate will be below the natural rate of unemployment.

Explanation:

If the economy is at potential GDP, and price level increase in the short-run, firms will earn more profit, because they will sell their goods and services for a higher price.

However, wages will not rise as fast, because they are usually fixed by contracts that do not change as fast as the price of goods and services. This phenomenon in economics is known as nominal rigidity.

Because of this nominal rigidity, hiring new workers will be cheaper than it should be, causing the unemployment rate to fall even below the natural rate.

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