Question

According to the Classical model, what happens when there is a recessionary GDP gap? (check all that apply)

a.The economy self-adjusts back to potential GDP

b.The economy stays in recession unless the government acts to increase aggregate demand

c.An excess supply of labor causes wage rates to fall

d.The price level rises

e.An excess demand for labor causes wage rates to rise

What are the implications of wages being "sticky downward"? (check all that apply)

a.Employers will lay off workers rather than cut wage rates

b.Disequilibrium can persist in labor markets

c.The aggregate supply curve will not fall enough to bring the economy back to potential GDP

d.A recessionary equilibrium can persist

Answer 1

According to classical model, when there is recessionary GDP gap

a. The economy self-adjusts back to potential GDP.

Explanation: since according to classical economy can self adjust itself in the long run and doesn't require any fiscal or monetary policy.

Implication of wages being "sticky downward"

a. Employers will layoff workers rather than cut wage rates.

Explanation : it means employers are unwilling ( rigid) to reduce (downward) salaries (wages) in dollar terms, as oppose to real terms. For example, in a deflationary period, employers will forever some of their workers rather than reducing wages across the board.