Which of the following alternatives best summarizes the Keynesian perspective of the Aggregate Demand/Aggregate Supply (AD/AS) model?

• A. Markets always clear quickly, and the economy naturally returns to full employment without government intervention.
• B. Long-run economic growth is determined solely by increases in the money supply.
• C. The economy can remain below full employment for extended periods due to sticky wages and prices, and government intervention may be necessary to restore equilibrium.
• D. Aggregate supply is perfectly elastic at all levels of output, so changes in aggregate demand only affect prices.

Answer: (C)

Verified step by step guidance

1. Step 1: Understand the Keynesian perspective on the AD/AS model, which emphasizes that wages and prices are 'sticky' or slow to adjust, preventing the economy from quickly returning to full employment after a shock.
2. Step 2: Recognize that because of this stickiness, the economy can remain in a state of underemployment equilibrium for a prolonged period, meaning output and employment are below their potential levels.
3. Step 3: Note that Keynesians argue government intervention, such as fiscal or monetary policy, may be necessary to boost aggregate demand and help the economy reach full employment.
4. Step 4: Contrast this with classical views where markets clear quickly and the economy self-corrects without intervention, and with other incorrect statements such as aggregate supply being perfectly elastic or long-run growth depending solely on money supply.
5. Step 5: Conclude that the best summary of the Keynesian perspective is that the economy can stay below full employment due to sticky wages and prices, and government action may be needed to restore equilibrium.