Answer the following information by using the following data. Full employment occurs when GDP is $514...

Answer the following information by using the following data. Full employment occurs when GDP is $514 billion. The economy’s equilibrium occurs when GDP is $510 billion. According to the classical economists what problem would be illustrated with this economy? According to Classical Theory, how would this problem be solved?

Expert Solution

Full Employment GDP = $514 bn

Equilibrium GDP = $510 bn

So, the economy is producing less than what it should be producing in the long run. The Actual GDP < Potential (Full employment) GDP and this gap between two outputs is called RECESSIONARY GAP.

So, the economy is facing a problem of the recessionary gap of 514 - 510 = $4 bn

CLASSICAL SOLUTION TO THE PROBLEM:

The equilibrium output is to the left and below the long-run full-employment output. Classical Economics are not in the favor of government intervention to reduce the gap. They believe that the market forces will drive the equilibrium back to the long-run equilibrium level. So, they treat prices and wages to be flexible.

According to the theory, the workers start accepting lower wages due to the fear of getting unemployed. As a result, the prices of resources will fall down and this will lead to an increase in the Aggregate Supply in the economy. This increase in AS so much so that the economy reaches the full employment output of $514 bn and the output gap is closed.

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Rahul Sunny answered 6 months ago

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