Consider the following short run aggregate supply equation: Y = $\hat Y$ + b (P - Pᵉ),where Y is the real output, $\hat Y$ is the full employment output,P and Pᵉ are the actual and expected price levels,respectively.Which of the following is correct?
A)In the classical model,P is always equal to Pᵉ because of price misperception assumption.
B)In the classical model,P may be different than Pᵉ because of price misperception assumption.
C)In the classical model,P is always greater than Pᵉ because of price misperception assumption.
D)In the classical model,P is always less than Pᵉbecause of price misperception assumption.

Question

Quizplus · Accepted Answer

In the classical model, P may be different from Pᵉ due to the assumption of price misperception. As per the assumption, firms may not be able to distinguish whether the change in the price level is due to a change in demand or a change in the overall price level, leading to a temporary disequilibrium between the actual and expected price levels. This leads to a short-run relationship between output and the difference between actual and expected price levels, as given by the short run aggregate supply equation.

Consider the Following Short Run Aggregate Supply Equation: Y = Y^\hat YY^

Consider the Following Short Run Aggregate Supply Equation: Y = $\hat Y$