Which of the following statements about inflation is true in the short run?

• A. In the short run, inflation has no effect on the unemployment rate.
• B. In the short run, an increase in aggregate demand can lead to higher inflation and lower unemployment.
• C. In the short run, inflation is solely caused by changes in the money supply.
• D. In the short run, inflation always leads to a decrease in real GDP.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the short-run relationship between inflation and unemployment, often described by the Phillips Curve, which suggests that in the short run, there is a trade-off between inflation and unemployment.
2. Step 2: Recognize that an increase in aggregate demand shifts the aggregate demand curve to the right, which can raise the price level (inflation) and increase output, thereby reducing unemployment temporarily.
3. Step 3: Note that inflation in the short run is not solely caused by changes in the money supply; other factors like demand shocks can also influence inflation.
4. Step 4: Understand that inflation does not always lead to a decrease in real GDP in the short run; in fact, higher inflation due to increased demand can coincide with higher real GDP.
5. Step 5: Conclude that the statement 'In the short run, an increase in aggregate demand can lead to higher inflation and lower unemployment' aligns with the short-run economic theory and is therefore true.