Within the Keynesian model, if the output of an economy is less than the full-employment level, then
A) a reduction in government expenditures will direct the economy back to full-employment equilibrium.
B) a reduction in wage rates and resource prices will quickly restore full-employment equilibrium.
C) a reduction in the real interest rate will soon restore full-employment equilibrium.
D) output will tend to remain below full-employment capacity unless aggregate expenditures increase.

Question

Quizplus · Accepted Answer

According to the Keynesian model, if the output of an economy is less than the full-employment level, then output will tend to remain below full-employment capacity unless aggregate expenditures increase. This means that there is a need for government intervention through increasing government spending, reducing taxes or implementing other fiscal policies to increase aggregate demand and restore full-employment equilibrium. A reduction in government expenditures (choice A) would further reduce aggregate demand, worsening the situation. Similarly, reducing wage rates and resource prices (choice B) may not increase demand sufficiently to restore full employment, as consumers may choose to save rather than spend the extra income. Moreover, this approach can lead to a deflationary spiral, where falling prices and wages further reduce demand and output. Finally, reducing the real interest rate (choice C) may stimulate investment and consumption, but it may be insufficient to close the output gap and restore full employment.

Within the Keynesian Model, If the Output of an Economy