Figure 7-4

-According to the classical economists when aggregate demand declines,AD₀ to AD₁ in the figure above,and output,falls below the natural rate of unemployment at 3000,wages and prices would
A)fall to E₁ causing output to rise and unemployment would be temporary.
B)rise to E₀ causing output to rise and unemployment would be temporary.
C)rise to A causing output to fall and unemployment would be temporary.
D)fall to A causing output to fall and unemployment would be permanently increased.

Question

Figure 7-4
 
-According to the classical economists when aggregate demand declines,AD₀ to AD₁ in the figure above,and output,falls below the natural rate of unemployment at 3000,wages and prices would
A)fall to E₁ causing output to rise and unemployment would be temporary. 
B)rise to E₀ causing output to rise and unemployment would be temporary. 
C)rise to A causing output to fall and unemployment would be temporary. 
D)fall to A causing output to fall and unemployment would be permanently increased.

Quizplus · Accepted Answer

Classical economists believe that when aggregate demand declines, causing output to fall below the natural rate of unemployment, wages and prices would adjust downwards. This adjustment (falling wages and prices) would lead to an increase in output and a return to the natural rate of unemployment, making any unemployment temporary. This process is described by moving to point E₁ in the classical model, where the economy self-corrects through flexible wages and prices.

Figure 7-4 -According to the Classical Economists When Aggregate Demand Declines,AD₀ to Aggregate