Exhibit 20A-2 Macro AD/AS Models In Panel (a) of Exhibit 20A-2, the economy is initially in short-run equilibrium at real GDP level Y₁ and price level P₂. Classical theory argues that: A) SRAS will shift to leftward and establish full employment at P₃Y_p without government intervention. B) higher wages will result in a leftward shift of SRAS. C) long-run equilibrium will be established at Y_p and P₁. D) all of the above will take place.

Question

Quizplus · Accepted Answer

According to classical theory, in the long run, wages and prices are fully flexible and will adjust to reach full employment at the natural rate of unemployment. This means that the SRAS curve will shift leftward until it intersects with the vertical LRAS curve at the potential output level (Y_p) and the original price level (P₁). Therefore, long-run equilibrium will be established at Y_p and P₁. Option A is incorrect because the classical theory does not require any government intervention to establish full employment in the long run. Option B is incorrect because the classical theory assumes that wages and prices are fully flexible and will adjust to changes in demand and supply conditions.

Exhibit 20A-2 Macro AD/AS Models in Panel (A) of Exhibit