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Layout the classical view of what will occur when SRAS intersects with AD at a point...

Layout the classical view of what will occur when SRAS intersects with AD at a point short of LRAS (a point where there is an undesirable level of unemployment, a lagging economy).

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Answer #1

In the classical economy the wages and price are very flexible and adjust immediately to take out any shortage or surplus in the market. If there is deflationary gap (equilibrium point short of potential output), the unemployment will be high and output will be low. AS the unemployed labor supply is more that will decrease the wages and at a lower wage the firm can hire more and produce more at a cheaper cost,

The price of the output will decease, the low wages will increase the demand for labor and increase the employment, that will continue to the point where the economy is at full employment level.

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