According to the classical model, if the economy starts at full employment an increase in aggregate demand will cause all of the following to occur except
A.
a decrease in wage rates.
B.
a decrease in unemployment.
C.
a rise in real GDP above its long-run level.
D.
an increase in input prices.
A. a decrease in wage rates.
According to the classical model, if the economy starts at full employment, an increase in aggregate demand will cause all of the following to occur except A decrease in wage rates (option A). The classical model assumes that wages and prices are flexible, and any increase in aggregate demand will be met with an increase in prices, not a decrease in wage rates. Therefore, the correct answer is A.
To determine the correct answer, let's analyze each option and the impact of aggregate demand (AD) on them:
A. A decrease in wage rates: According to the classical model, an increase in AD would not cause a decrease in wage rates. In fact, the classical model assumes that wages and prices are flexible and adjust freely in response to changes in demand and supply. Therefore, this option is a potential outcome of an increase in aggregate supply (AS), rather than an increase in AD. Since the question specifically mentions an increase in AD, we can eliminate option A.
B. A decrease in unemployment: In the classical model, the economy is assumed to be at full employment, meaning there is no cyclical unemployment. If AD increases while the economy is at full employment, it would not cause a decrease in unemployment. Therefore, this option is not expected to occur.
C. A rise in real GDP above its long-run level: According to the classical model, the long-run level of real GDP is determined by the economy's productive capacity and does not depend on changes in AD. In the long run, the economy will return to its potential output level, regardless of fluctuations in AD. Therefore, an increase in AD is not expected to cause real GDP to rise above its long-run level. Thus, this option is not expected to occur.
D. An increase in input prices: In the classical model, changes in AD do not lead to changes in input prices. The model assumes that input prices, such as wages and raw material costs, are flexible. Any increase in input prices would be a result of factors other than changes in AD. However, this option states that an increase in input prices would not occur, which aligns with the classical model.
Based on this analysis, the answer to the question is option B: a decrease in unemployment. An increase in AD, while the economy is at full employment, is not expected to cause a decrease in unemployment according to the classical model.