Chapter_17_Key_Question_Solutions - 17-1 (Key Question) Use...

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17-1 ( Key Question ) Use the aggregate demand-aggregate supply model to compare the “old” classical and Keynesian interpretations of (a) the aggregate supply curve, and (b) the stability of the aggregate demand curve. Which of these interpretations seems more consistent with the realities of the Great Depression? (a) Classical economists envisioned the AS curve as being perfectly vertical. When prices fall, real profits do not decrease because wage rates fall in the same proportion. With constant real profits, firms have no reason to change the quantities of output they supply. Keynesians viewed the AS curve as being horizontal at outputs less than the full-employment output and vertical only at full employment. Declines in aggregate demand do not change the price level because wages and prices are assumed to be inflexible downward. (b) Classical economists viewed AD as stable so long as the monetary authorities hold the money supply constant. Therefore inflation and deflation are unlikely.
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Chapter_17_Key_Question_Solutions - 17-1 (Key Question) Use...

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