2.4.3 Equilibrium Levels of National Output — Practice Questions

Seven original multiple-choice questions on equilibrium levels of real national output, written to the style and difficulty of Edexcel Paper 2 Section A. One asks you to sketch the diagram.

7 questions Edexcel A-Level Multiple choice Model answers included

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1. 1. Short-run macroeconomic equilibrium occurs at the level of real output where

   Definition in context

   Select one answer

   A AD equals LRAS.

   B AD equals SRAS.

   C Injections equal withdrawals.

   D SRAS equals LRAS.
   Show model answer

   Answer: B (AD equals SRAS.). The short run is the period in which at least one factor of production is fixed, so the relevant supply curve is SRAS.
   Where AD crosses SRAS determines both the actual price level and the actual level of real national output — what the economy is producing, as distinct from what it could produce.
   Long-run equilibrium is a stronger condition. On the Classical view it requires AD = SRAS = LRAS, all at the full employment level of output.

   Why the other options are wrong

   • A — AD equalling LRAS is part of the long-run condition, and on its own it does not fix the short-run price level.
   • C — J = W is the equilibrium condition for the circular flow of income. It is a different model, though a consistent one.
   • D — SRAS crossing LRAS says where the short-run curve happens to meet capacity. Equilibrium requires demand to be there too.

2. 2. In the Keynesian model an economy can settle in long-run equilibrium below the full employment level of output. The implication is that

   Applied reasoning

   Select one answer

   A Aggregate demand cannot affect real output.

   B Prices and wages adjust quickly to restore Yfe.

   C The economy will always self-correct in time.

   D Unemployment can persist without intervention.
   Show model answer

   Answer: D (Unemployment can persist without intervention.). This is the heart of the Keynesian position, and the reason it carries a policy conclusion.
   Because the L-shaped LRAS curve permits equilibrium at output levels below Yfe, an economy can come to rest with unused capacity and unemployed workers and simply stay there. Nothing in the model drags it back on its own.
   If that is right, waiting is not a policy. Government has to shift aggregate demand to move the economy towards full employment — which is exactly what the Classical model says is unnecessary and ineffective.

   Why the other options are wrong

   • A — The opposite. The Keynesian case is that aggregate demand does determine real output below full capacity.
   • B — Rapid wage and price adjustment is the Classical mechanism. It is what the Keynesian model doubts.
   • C — Self-correction is the Classical claim. Equilibrium persisting below Yfe is precisely a failure to self-correct.

3. 3. In the Classical model an economy is temporarily producing below Yfe. The mechanism that returns it to Yfe is

   Applied reasoning

   Select one answer

   A An increase in government spending.

   B An outward shift of the LRAS curve.

   C Adjustment of wages and prices downwards.

   D A permanent fall in the general price level.
   Show model answer

   Answer: C (Adjustment of wages and prices downwards.). The Classical model is built on markets clearing. With output below capacity there is spare labour and idle equipment, so wages and prices fall.
   Lower costs shift SRAS to the right, and the economy slides back to Yfe of its own accord. No policy is needed, and the deviation is temporary by construction.
   The Keynesian objection is empirical rather than logical: wages in particular are slow to fall, so the adjustment may take long enough that waiting for it is not a serious option.

   Why the other options are wrong

   • A — Government spending is the Keynesian remedy. The Classical claim is that no intervention is required.
   • B — An outward LRAS shift would raise Yfe itself. The question is about returning to the existing Yfe, not moving it.
   • D — The price level does fall during the adjustment, but that is part of the mechanism rather than the end state. Once at Yfe there is no further downward pressure.

4. 4. A government raises aggregate demand. Whether real output rises as a result depends most on

   Applied reasoning

   Select one answer

   A How large the country's trade deficit is.

   B Where the economy is on the LRAS curve.

   C Whether the budget is in deficit or surplus.

   D Whether the injection is investment or spending.
   Show model answer

   Answer: B (Where the economy is on the LRAS curve.). The same rightward shift in AD produces completely different outcomes depending on where it lands.
   On the horizontal section of a Keynesian LRAS curve, with large spare capacity, output rises and prices barely move. On the upward-sloping section both rise. On the vertical section — or anywhere on a Classical LRAS — output cannot rise at all and the whole effect falls on the price level.
   This is why the state of the economy matters more than the size of the stimulus, and why the same policy is right in a slump and wrong at the peak.

   Why the other options are wrong

   • A — A trade deficit affects the size of the multiplier through import leakage, but it does not determine whether extra demand can be met with extra output.
   • C — The budget position is about how the spending is financed. The supply side decides whether the economy can produce more.
   • D — Both are injections and both shift AD right. What happens next depends on capacity, not on which component moved.

5. 5. An economy's LRAS curve shifts outward while aggregate demand is unchanged. Compared with before, the new long-run equilibrium has

   Applied reasoning

   Select one answer

   A Higher output and a higher price level.

   B Higher output and a lower price level.

   C Lower output and a higher price level.

   D Lower output and a lower price level.
   Show model answer

   Answer: B (Higher output and a lower price level.). Productive capacity has risen, so the economy can produce more. With demand unchanged, that extra supply has to find buyers, and the way it does so is through a lower price level.
   So the new equilibrium sits at higher output and lower prices — the combination every government wants and the reason supply-side improvement is treated as the route to non-inflationary growth.
   It is worth contrasting with the demand-side case: raising AD alone buys output at the cost of higher prices, while raising LRAS delivers more output and eases them.

   Why the other options are wrong

   • A — A higher price level accompanies a rise in demand. Here supply has risen against unchanged demand, which pushes prices down.
   • C — Output cannot fall when capacity has increased and demand has not changed.
   • D — The price level does fall, but output rises rather than falling. More capacity means more can be produced.

6. 6. Sketching both models, aggregate demand rises by the same amount in a Classical economy at Yfe and in a Keynesian economy with large spare capacity. Compared with the Classical case, the Keynesian case gives

   Applied reasoning Sketch to solve

   Select one answer

   A More output and less inflation.

   B More output and more inflation.

   C Less output and less inflation.

   D Less output and more inflation.
   Show model answer

   Answer: A (More output and less inflation.). Draw the two side by side and the contrast is stark.
   In the Classical economy, LRAS is vertical at Yfe. AD shifts right, output cannot move, and the entire adjustment lands on the price level — pure inflation, no growth.
   In the Keynesian economy with large spare capacity, the relevant section of LRAS is horizontal. Idle resources are drawn in at unchanged cost, so output rises and the price level barely moves.
   Same policy, opposite results — which is why the disagreement between the two schools is about far more than the shape of a curve.

   Why the other options are wrong

   • B — Inflation is lower in the Keynesian case, not higher. Spare capacity is what keeps costs and prices flat as output expands.
   • C — Output is higher in the Keynesian case. In the Classical case it does not rise at all.
   • D — Both halves are wrong: the Keynesian case delivers more output and less inflation than the Classical one.

7. 7. An economist argues that demand-side stimulus is pointless and that only supply-side reform can raise output in the long run. This position follows most directly from

   Applied reasoning

   Select one answer

   A The circular flow model of national income.

   B The Keynesian view of long-run equilibrium.

   C The multiplier process during a recession.

   D The vertical LRAS curve of the Classical model.
   Show model answer

   Answer: D (The vertical LRAS curve of the Classical model.). If LRAS is vertical at full employment, then long-run output is fixed by the quantity and quality of the factors of production and nothing else.
   Shifting AD right along a vertical curve raises the price level and leaves output exactly where it was — so demand management can generate inflation but not growth. The only way to raise output is to move the curve itself, which means supply-side reform: skills, investment, technology, competition, institutions.
   The argument is a direct consequence of the model's shape, which is why the Classical and Keynesian views lead to such different policy prescriptions.

   Why the other options are wrong

   • A — The circular flow describes how income moves between agents. It says nothing about whether output is capacity-constrained in the long run.
   • B — The Keynesian view is the opposite: below full employment, demand does determine output, so demand-side stimulus works.
   • C — The multiplier is an argument for the potency of demand-side policy, particularly in a recession when spare capacity is plentiful.