Answer to Question 3:

According to the auction theory, an increase in the unemployment rate above the natural level is the result of a decline in the general price level below the level expected.

True or False?

The statement is true. A decline in employment (increase in the unemployment rate) in response to a decline in aggregate demand takes place because workers and firms do not realize the extent to which observed demand changes are economy-wide rather than industry specific. Workers adjust their labour supply curve down by the amount they think the equilibrium price level has declined. Any further decline in demand is assumed to be industry-specific, with the result that a movement to the left along the supply curve of labour occurs as workers substitute leisure for work on the expectation that the industry-specific decline is temporary. As output falls, the actual price level falls further than expected.

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