Chapter 4R, Problem 10MCQ

To determine

What happens when potential output is equal to aggregate actual output in an economy?

Explanation of Solution

The economy experiences inflation when the actual output is greater than the potential output.

When the economy experiences cyclical unemployment, the actual output is less than the potential output and not equal.

Nominal wages are sticky to determine the short-run equilibrium, not to determine the long-run equilibrium.

When the potential output is equal to the actual output, the economy is in long-run equilibrium.

The aggregate price level rises when there is an inflationary gap and not when actual output is equal to potential output.

Hence, option ‘d’ is the correct option.

When prices in an economy increase or when the purchasing power of money decreases, this is referred to as inflation. Hence, option (a) is incorrect.

The economic policy places a lot of emphasis on cyclical unemployment, which often increases during recessions and decreases during economic expansions. Hence, option (b) is incorrect.

According to the sticky wage theory, workers are hesitant to accept decreases in nominal wages, which causes nominal wages to respond slowly and rigidly downward to changes in a company's and the overall economy's performance. Hence, option (c) is incorrect.

The price level rises when aggregate demand rises; the opposite is true when aggregate demand declines and the price level falls. Hence, option (e) is incorrect.

Economics Concept Introduction

Potential output is the output level that can be produced by the economy given it attains a full employment level. Actual output is the output level that is actually produced by the economy.