Contrast the active policy view of the behavior of wages and prices during a contractionary gap with the passive policy view.

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pohnpei397 eNotes educator| Certified Educator

This is a question about how to close a contractionary gap in an economy.  It is asking whether the government should be passive or active in trying to close that gap.

A passive approach relies on the classical view of economics.  This is a view that holds that the economy will fix itself and return to full employment without government intervention.  This view holds that wages and prices will change freely and quickly.  For example, when there is a contractionary gap, sellers will lower their prices because they know people cannot afford the higher prices.  Workers will notice that prices are dropping and will accept lower wages.  This will increase aggregate supply and the economy will return to full employment.

An active approach relies on a Keynesian view of economics.  Here, the assumption is that wages and prices will be “sticky.”  That is, they will not readily change on their own.  People who believe this feel that sellers and workers will be reluctant to drop their prices (wages are the price of labor, of course).  Therefore, the gap will not close on its own.  Instead, the government will have to step in with expansionary fiscal and monetary policy to close the contractionary gap.

Thus, the difference is that the active policy view believes that wages and prices are sticky while the passive policy view believes that will move freely and quickly.