Question

Prior to the Great Depression, classical economists believed that a recessionary downturn would be reversed by:

a. higher wages and prices.
b. lower wages and prices.
c. an expansionary monetary policy on the part of the Federal Reserve System.
d. an increase in government spending that would stimulate aggregate demand.

Answer 1

Classical economists believed that a recessionary downturn would be reversed by lower wages and prices, as the economy would naturally adjust back to full employment. They advocated for a 'hands off' approach to fiscal and monetary policy.

Step-by-step explanation:

Prior to the Great Depression, classical economists believed that a recessionary downturn would be reversed by lower wages and prices. This belief was rooted in the idea that the economy, with flexible prices, would naturally adjust back to full employment. Thus, if the economy found itself in a recession, characterized by a surplus of goods and services, it was expected that this surplus would be eliminated through the reduction in prices and wages, leading to an increase in demand, and eventually restoring the economy to the full employment level of GDP.

The classical view implied a vertical aggregate supply curve at full employment GDP, advocating a "hands off" policy approach. They believed that no active fiscal or monetary policy was necessary, and that such policies might in fact lead to inflation without helping to increase GDP. It was only after the impacts of the Great Depression that Keynesian economics came into prominence, suggesting that active fiscal policies were needed to tackle weak aggregate demand and combat economic downturns.