Final answer:
In the short run, an unanticipated increase in the money supply will increase employment but not affect real output in the long run, where it will only lead to higher inflation. Real output will adjust back to its full-employment equilibrium level due to the flexibility of wages and prices over time.
Step-by-step explanation:
An unanticipated increase in the money supply in the short run will increase employment due to lower real wages, which make hiring workers cheaper and stimulate increased production. This is because prices, including wages, are sticky in the short run, and firms can increase output before workers demand higher wages due to higher prices. In the long run, a sustained increase in the money supply will not increase real output; instead, it will just increase inflation. Real output will return to its full-employment level, and the only long-term effect of increasing the money supply is a proportional increase in the price level.
According to neoclassical economics, in the long run, an economy is expected to return to the natural level of real GDP where full employment is achieved, irrespective of changes in aggregate demand, as wages and prices become flexible. Increased money supply does not permanently affect real output and unemployment; instead, aggregate supply and potential GDP determine the real size of the economy when the economy adjusts in the long run.