What occurs in the classical model when aggregate demand decreases?

In the classical model of economics, the relationship between aggregate demand and price levels is crucial. When aggregate demand decreases, firms are faced with reduced demand for their goods and services. In the short term, this situation may suggest the need for prices to adjust downwards to stimulate demand. However, the classical model posits that prices are flexible and therefore will adjust to changes in demand over time.

Specifically, while a decrease in aggregate demand could initially suggest a lower level of real GDP due to decreased production and consumption, the classical model asserts that the economy operates at full employment in the long run. Therefore, prices will eventually decrease to restore equilibrium between supply and demand, but real GDP will ultimately remain unchanged at its natural rate. This is because, in the long run, the economy’s output is determined by factors like technology and resources, rather than aggregate demand.

Thus, the correct answer reflects that in the classical model, a decrease in aggregate demand leads to a decrease in prices while real GDP remains at its long-run potential level, indicating that the real output is not affected by changes in aggregate demand in the long run.