Full-employment output is the level of output that firms in the economy supply when
(a) taxes are zero.
(b) wages and prices have fully adjusted.
(c) the unemployment rate is zero.
(d) all capital is fully utilized.
The correct answer and explanation is:
The correct answer is (b) wages and prices have fully adjusted.
Full-employment output refers to the level of output produced in an economy when all resources, including labor and capital, are fully utilized in the most efficient way possible, and there is no cyclical unemployment. It occurs when wages and prices have fully adjusted to market conditions, balancing supply and demand in the labor and goods markets.
At full employment, the economy operates at its potential output, meaning the level of output that would be produced if all factors of production (labor, capital, land, and entrepreneurship) were employed at their optimal capacity. Importantly, this does not mean there is zero unemployment; rather, it reflects the natural rate of unemployment, which includes frictional and structural unemployment. Frictional unemployment occurs when workers are temporarily unemployed while transitioning between jobs, and structural unemployment arises when workers’ skills do not match available job opportunities.
The concept of full-employment output assumes that wages and prices have fully adjusted to any previous economic shocks. If wages and prices are sticky, meaning they do not adjust immediately, the economy may operate below or above full employment in the short run. However, in the long run, wages and prices are assumed to adjust, ensuring that the economy operates at the full-employment output level.
While other choices may seem plausible, they do not directly address the condition under which the economy reaches full-employment output. For example, zero taxes or zero unemployment are not necessary conditions for full-employment output. Additionally, fully utilizing capital is important, but it is not the only factor determining the full-employment output level. The key is the adjustment of wages and prices to bring the economy to its potential output.