Question

If the economy is operating in the neoclassical zone of the SRAS curve and aggregate demand falls, what is likely to happen to real GDP?

Short answer

If the economy is operating in the neoclassical zone of the SRAS curve and aggregate demand falls, real GDP is likely to remain unchanged, as the economy is already at its full capacity or full employment level. The fall in aggregate demand will primarily affect the price level, resulting in deflation.

Step-by-step solution

Understand the SRAS Curve and its Zones

The short-run aggregate supply (SRAS) curve shows the relationship between the price level and real GDP in the short run, keeping all other factors constant. The SRAS curve has three zones: Keynesian, Intermediate, and Neoclassical. Each zone represents a different level of output and economic behavior. 1. Keynesian Zone: In this zone, the SRAS curve is horizontal, and the economy operates at a level of output below full employment. A change in aggregate demand does not affect the price level but can influence real GDP. 2. Intermediate Zone: The SRAS curve has a positive slope in this zone. The economy is operating at a level of output between the Keynesian and Neoclassical zones. A change in aggregate demand can affect both the price level and real GDP. 3. Neoclassical Zone: In the Neoclassical zone, the SRAS curve becomes vertical, and the economy operates at full employment. A change in aggregate demand does not affect real GDP but can influence the price level.

Neoclassical Zone and Aggregate Demand

According to the question, the economy is operating in the neoclassical zone of the SRAS curve. In the neoclassical zone, the SRAS curve is vertical, indicating that the economy is producing at its full capacity or full employment level. At this point, any change in aggregate demand will not affect the level of real GDP, as the economy is already producing at its maximum potential.

Analyzing the Effect of Falling Aggregate Demand

Now we need to analyze the impact of a fall in aggregate demand on real GDP when the economy is operating in the neoclassical zone of the SRAS curve. A fall in aggregate demand refers to a decrease in the overall demand for goods and services in the economy. When aggregate demand decreases, the aggregate demand curve shifts to the left. In the neoclassical zone, since the SRAS curve is vertical, a leftward shift in the aggregate demand curve will not affect real GDP as the economy is already producing at its full capacity. The fall in aggregate demand will only influence the price level, leading to a decrease in the price level or deflation.

Conclusion

To summarize, if the economy is operating in the neoclassical zone of the short-run aggregate supply curve and aggregate demand falls, the real GDP is likely to remain unchanged. The economy will continue to operate at its full capacity or full employment level, and the only impact will be on the price level, which will decrease.