Consider the following statements about the fixed price level in the first stage of macroeconomic analysis:
(A) The fixed price level is a permanent assumption that is not changed later.
(B) With unused machines, buildings and labour, the law of diminishing returns applies with full force.
(C) With unused resources, additional output can be produced without increasing marginal cost.
(D) In the first stage, macroeconomic equilibrium is worked out taking the price level as fixed.
(E) In the second stage, the price level is allowed to vary.
Which of the statements given above are correct?
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → (C), (D) and (E) only
(A) The fixed price level is a permanent assumption that is not changed later. — Incorrect. The fixed price is a simplifying assumption which will be changed later.
(B) With unused machines, buildings and labour, the law of diminishing returns applies with full force. — Incorrect. With unused resources, the law of diminishing returns does not apply.
(C) With unused resources, additional output can be produced without increasing marginal cost. — Correct. So the price level need not rise as output rises.
(D) In the first stage, macroeconomic equilibrium is worked out taking the price level as fixed. — Correct. This is the first stage.
(E) In the second stage, the price level is allowed to vary. — Correct. This is the second stage.
NCERT (2026-27): “4.3 Determination of Equilibrium Income in the Short Run You would recall that in microeconomic theory when we analyse the equilibrium of demand and supply in a single market, the demand and supply curves simultaneously determine the equilibrium price and the equilibrium quantity. In macroeconomic theory we proceed in two steps: at the first stage, we work out a macroeconomic equilibrium taking the price level as fixed. At the second stage, we allow the price level to vary and again, analyse macroeconomic equilibrium. What is the justification for taking the price level as fixed? Two reasons can be put forward: (i) at the first stage, we are assuming an economy with unused resources: machineries, buildings and labours. In such a situation, the law of diminishing returns will not apply; hence additional output can be produced without increasing marginal cost. Accordingly, price level does not vary even if the quantity produced changes (ii) this is just a simplifying assumption which will be changed later.” |