Question

In: Economics

a) The Classical Macroeconomic model suggests no need for the government to stabilize the economy using...

a) The Classical Macroeconomic model suggests no need for the government to stabilize the economy using monetary or fiscal policy. Explain this statement in the AD-AS framework.

b) Explain how the expectations and redistribution effects destabilize the economy when prices are rising.

Solutions

Expert Solution

a)

Classical economists assume that full employment is general condition. Government should not make any intervention in economic activities, it would lead to inefficient outcomes only. Flexible price and wage rate would automatically give rise to the output level and employments. If due to any reasons, demand falls, it would again shifts to its previously level without government intervention.

Thus, if wage and prices are flexible, government should not make intervention through monetary and fiscal policies,

b)

Marginal rise in inflation could be beneficial to economy. But when there is high rise in inflation rate, it leads to negative sentiments in economy. Investors reduce their investment for fear of losing their money. Further, income inequalities rise, and rich class converts their money into stable valued assets.

Here, government must use monetary and fiscal policies to rein in inflationary pressures.

Rahul Sunny answered 1 year ago
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