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Classical economists belief that prices and quantities adjust to the changes in the forces of supply...

Classical economists belief that prices and quantities adjust to the changes in the forces of supply and demand and that the economy produces its potential output in the long run. On the contrary, Keynesian economists believe because of price and wage rigidities the economy’s equilibrium output in the long run may be less than its potential output. What is price-wage rigidity? Do you agree with Keynes assessment that wage-price rigidity requires government’s involvement in the markets? Why? Why not?

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Expert Solution

Answer : Price-wage rigidity : The price - wage rigidity means that the price level of goods and services and the wage rate of labor are sticky. This means that the price and wages changes very slowly at any situation.

Yes, I agree that the government should involve in the market in price-wage rigidity situation. Because price-wage rigidity tend to decrease the aggregate demand which shift the aggregate demand curve to leftward. As a result, the equilibrium output is less than the potential output level. In this situation the government should decrease the price and wage level. Because of lower price and wage rate the aggregate demand will increase which will shift the aggregate demand curve to rightward. As a result, the equilibrium output level will be equal to the potential output level. Therefore, according to me, in case of price-wage rigidity the government should involve in the market.

Rahul Sunny answered 2 years ago
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