Start at full-employment (FE) equilibrium with flexible wages and worker misperception of price level changes in the short run. Suppose then that we have an increase in Aggregate Demand. First, think about the short-run effects on price level (P), output level (Q), wage level (W), employment (L), and unemployment (U)?
In the long run, once workers realize that there was a change in the price level, they will change the supply curve of labor. When all subsequent wage and price adjustments take place, we will be in a new long-run equilibrium. From the original full-employment (FE) equilibrium to the final one, what is the net change in the price level (P), output level (Q), unemployment (U), and the real wage (W/P)?
A) No change in P, no change in Q, an increase in U and no change in W/P.
B) No change in P, an increase in Q, an increase in U and an increase in W/P.
C) An increase in P, an increase in Q, no change in U and a decrease in W/P.
D) An increase in P, no change in Q, no change in U and no change in W/P.
E) An increase in P, no change in Q, an increase in U and no change in W/P.