Question

“If prices and wages are perfectly flexible, then and changes in aggregate demand have a smaller effect on output.” Is this statement true, false, or uncertain? Explain your answer.

Short answer

The statement is false.

Step-by-step solution

Step 1. Define aggregate demand.

Aggregate demand is defined as the total amount of demand produced in the economy for all finished goods and services.

Step 2. Is the given statement true, false or uncertain?

The sensitivity of inflation to the output gap is symbolized by the symbol $\gamma$. If wages and prices are completely flexible, $\gamma$ will be quite large, indicating a high degree of sensitivity. Changes in aggregate demand would have a tremendous influence on output since aggregate demand is so sensitive.