Question

Will an increase in an economy’s potential output, caused by supply-side policies, result in an increase in real output? (multiple choice)

a) According to the monetarist/neo-classical school an increase in potential output always results in an increase in real output, but according to the Keynesian school an increase in potential output only increases real output if the economy is already producing close to full capacity.

b) Yes, an increase in potential output always results in an increase in real output according to both the monetarist/neo-classical school and the Keynesian school.

c) According to the monetarist/neo-classical school an increase in potential output always results in an increase in real output, but according to the Keynesian school an increase in potential output never results in an increase in real output.

d) No, an increase in potential output does not result in an increase in real output according to both the monetarist/neo-classical school and the Keynesian school.

Answer 1

ANSWER: (C)

According to neo-classical school of economics, an increase in potential output always results in an increase in real output as the size of potential output is the factor that mainly determines the real output. In a neo-classical zone, the cyclical unemployment is relatively low and consumption factors are always in the positive side, the change in aggregate demand doesn't always play a role in determining the output. Only a change in aggregate supply can cause changes in real output of the economy.

According to Keynesian school, an important factor is played by the aggregate demand as the economy night face challenges and the real output could go less than the potential output. The rise in unemployment due to recession is always possible and only if there is aggregate demand, the real output will go up in that economy. Availability of factors of production determines the potential output of an economy while when it comes to the real output, demand side is noted and have an impact.