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 P₃Yp without government intervention.
B) higher wages will result in a leftward shift of SRAS.
C) long-run equilibrium will be established at Yp and P₁.
D) all of the above will take place.

Question

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 P₃Yp without government intervention. 
B) higher wages will result in a leftward shift of SRAS. 
C) long-run equilibrium will be established at Yp and P₁. 
D) all of the above will take place.

Quizplus · Accepted Answer

According to classical theory, in the long run, prices and wages are flexible and will adjust to bring the economy to full employment at the potential output level (Yp) and the natural price level (P₁). Therefore, the short-run equilibrium point (Y₁, P₂) will adjust over time to reach the long-run equilibrium point (Yp, P₁). Option A is incorrect because classical theory does not require government intervention to bring the economy to full employment. Option B is a partial statement of the classical theory, but it does not fully capture the theory's prediction regarding the adjustment to full employment.