6) According to Classical theory, the economy is self-regulating. If it is in a

Question

6) According to Classical theory, the economy is self-regulating. If it is in a recessionary gap, what happens? Question options:

Wages rise, the SRAS curve shifts leftward, and both Real GDP and the price level rise.

Wages fall, the SRAS curve shifts rightward, the price level falls, and Real GDP rises.

Wages fall, the SRAS curve shifts leftward, the price level rises, and Real GDP falls.

none of the above

7) According to the classical economists, which of the following statements is true?

Question options:

Financial markets ensure that S will equal I..

Interest rate flexibility will ensure that planned saving is equal to planned investment.

There is a direct relationship between the amount individuals plan to save and the interest rate - higher rates cause people to save more and lower rates reduce savings.

Interest rates determine how much business firms invest - higher interest rates reduce investment and lower rates increase investment.

All of the above are true.

10)

If actual Real GDP is greater than the full employment Real GDP, then the (actual) unemployment rate is

Question options:

greater than the natural unemployment rate and an inflationary gap exists.

less than the natural unemployment rate and a recessionary gap exists.

greater than the natural unemployment rate and a recessionary gap exists.

less than the natural unemployment rate and an inflationary gap exists.

equal to the natural unemployment rate and no gap exists.

Financial markets ensure that S will equal I..

Interest rate flexibility will ensure that planned saving is equal to planned investment.

There is a direct relationship between the amount individuals plan to save and the interest rate - higher rates cause people to save more and lower rates reduce savings.

Interest rates determine how much business firms invest - higher interest rates reduce investment and lower rates increase investment.

All of the above are true.

10)

If actual Real GDP is greater than the full employment Real GDP, then the (actual) unemployment rate is

Question options:

greater than the natural unemployment rate and an inflationary gap exists.

less than the natural unemployment rate and a recessionary gap exists.

greater than the natural unemployment rate and a recessionary gap exists.

less than the natural unemployment rate and an inflationary gap exists.

equal to the natural unemployment rate and no gap exists.

Explanation / Answer

Q6. According to Classical theory, the economy is self-regulating.

This means that prices and wages are fully flexible.

If economy is in recessionary gap then unemployment is increasing or is greater than the natural rate of unemployment.

In other words, supply of labor is exceeding the demand for labor at current wage rate.

With wages being flexible, this excess of supply of labor over demand will result in fall in wage rate.

Fall in wage rate will reduce the cost of production of firms and increase their profit-margin prompting them to produce more. This will increase aggregate supply in economy and SRAS curve will shift rightwards.

Given the AD curve, this rightward shift of SRAS curve will result in fall in price level and rise in real GDP.

Hence, the correct answer is option (2).

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