Questions and Answers
What was first produced by Adam Smith in the book 'An Inquiry into the Nature and Causes of the Wealth of Nations'?
What is the ideal quantity of total output according to classical economic theory?
The quantity that will yield full employment of labor and results in the natural unemployment rate.
According to classical economic theory, Real GDP may deviate from Natural Real GDP over the course of the business cycle.
True
What characterizes a market economy according to classical economic theory?
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What is Marx's criticism of classical theory?
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What does Say's Law state?
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What happens if the desire to save increases according to classical economic theory?
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According to classical economic theory, wages and prices are flexible.
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When Real GDP is less than Natural Real GDP, what does that imply?
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What occurs if Real GDP is greater than Natural Real GDP?
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What situation indicates a long-run equilibrium in classical economic theory?
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How is a recessionary gap automatically closed according to classical economic theory?
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What closes an inflationary gap according to classical economic theory?
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What describes the LRAS curve according to classical economic theory?
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According to classical economic theory, changes in aggregate demand affect only the price level in the long run.
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What is the recommended economic policy according to classical economic theory?
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Study Notes
Classical Economic Theory
- Developed by Adam Smith, highlighted in "An Inquiry into the Nature and Causes of the Wealth of Nations."
- Emphasizes that a market economy self-regulates to reach Natural Real GDP and natural unemployment rates.
Ideal Quantity of Total Output
- Achieves full labor employment, aligning with the natural unemployment rate.
- Identified as Natural Real GDP, it occurs automatically in a self-regulating economy.
Business Cycle and Real GDP
- Classical theory acknowledges deviations of Real GDP from Natural Real GDP throughout the business cycle.
Market Economy Functions
- Self-regulating mechanism adjusts to natural unemployment and Natural Real GDP.
- Flexible wages and prices eliminate labor market surpluses and shortages.
Marx's Critique
- Argues that market economies lack automatic adjustments to Natural Real GDP.
- Points out instability due to inadequate demand in a market economy.
Say's Law
- States supply generates its own demand; production results in income for resource owners.
- Assumes there will always be enough demand to meet supply levels.
Savings' Impact
- An increase in the desire to save causes a rightward shift in the savings supply curve.
Real GDP Comparisons
- When Real GDP is less than Natural Real GDP: indicates a recessionary gap, higher unemployment than natural rates, and falling wage rates.
- When Real GDP exceeds Natural Real GDP: indicates an inflationary gap, lower unemployment than natural rates, and rising wage rates.
- When Real GDP equals Natural Real GDP: the economy is in long-run equilibrium.
Closing Gaps
- Recessionary gap closures are driven by labor surpluses reducing wage rates, shifting the SRAS curve right until Real GDP matches Natural Real GDP.
- Inflationary gap closures occur as labor shortages increase wage rates, prompting a leftward shift in the SRAS curve until Real GDP equalizes with Natural Real GDP.
Long-Run Aggregate Supply (LRAS)
- LRAS curve remains vertical at Natural Real GDP, indicating stability.
- Changes in aggregate demand (AD) influence only the price level over the long run.
- Advocates for a laissez-faire economic policy, as the economy is inherently self-regulating.
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Description
Test your understanding of classical economic theory with these flashcards from Chapter 7. This quiz features key concepts and definitions introduced by Adam Smith and explores the implications of total output on employment. Perfect for students reviewing economic principles.
