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IAI Actuarial Core Principles · Business Economics · Main economic schools and their key features

According to Keynesian economics, which of the following best explains why an economy may remain in equilibrium with high unemployment for a prolonged period?

Keynesians hold that equilibrium can exist below full employment because aggregate demand is insufficient and wages and prices are sticky, so markets do not self-correct quickly. Say's law and complete crowding out belong to classical thinking, not the Keynesian explanation of persistent unemployment.

  1. AAggregate demand can be insufficient to employ all available labour, and wages and prices do not adjust quickly enough to restore full employmentCorrect
  2. BWorkers always choose leisure over work when real wages fall slightly
  3. CSupply creates its own demand, so unemployment is only voluntary
  4. DThe money supply grows faster than output in every recession
  5. Government spending always crowds out an equal amount of private spending

Explanation

Keynes argued that output is demand-determined in the short run. If aggregate demand is deficient and wages and prices are sticky, the economy can settle below full employment. Say's law and full crowding out are classical or monetarist ideas that Keynesians reject.

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