In the new classical model, ________.
A) all wages and prices are perfectly flexible with respect to expected changes in the price level
B) a fall in the expected price level results in an immediate and equal rise in wages and prices
C) only unanticipated policy can affect aggregate output and unemployment
D) A and C only

Question

Quizplus · Accepted Answer

In the new classical model, all wages and prices are perfectly flexible with respect to expected changes in the price level, which is the basis for the rational expectations theory. This means that if agents expect prices to increase, workers will demand higher wages and firms will raise prices accordingly. However, in this framework, only unanticipated policy can affect aggregate output and unemployment, as agents adjust their expectations and behavior accordingly. Therefore, choices A and C are both correct. Choice B is not accurate, as the new classical model assumes that wages and prices adjust simultaneously and proportionally to changes in expectations, rather than in a one-to-one relationship.

In the New Classical Model, ________