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- Chapter 8: Classical Model
Chapter 8: Classical Model
Economics 1020 with Periera at Tulane University
About this deck
By: Miranda Heater
Created: 2011-04-27
Size: 34 flashcards
Views: 19
Created: 2011-04-27
Size: 34 flashcards
Views: 19
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Main assumptions of the Classical Model
Markets clear
- QS=QD equilibrium
- real wages adjust to make this happen
- excess S, P rise
- excess D, P fall
- adjust and set themselves
Firms are profit maximizing and perfectly competitive
There is no cyclical unemployment in the classical model
How much output will we produce?
Determed by agreggate production function
- output vs fixed # of workers
- upward sloping
- (labor + capital + raw materials + technology)
Demand for labor
Price of labor is the real wage rate (adjusted for inflation)
- real wage rate vs units of labor
- slope downwards
- diminishing returns
- shifts right if productivity increases
supply of labor
Increases if
- population increases
- higher participation rate
How to determine output...
Labor market graph
- real wage rate vs # of workers
over Aggregate production function
- where equilibrium intersects aP
Say's Law
Supply creates its own demand
- equal amount of spending
- full employment can be maintained
- if there is excess, prices change to eliminate excess
- leakages = injections
- holds as long as the markets clear
What is the classical model better for?
Explaining the LR trend itself
What is the Keynesian model better for?
Describing economic fluctuations
- movements in outputs around its LR trend
Potential GDP
the maximum sustainable GDP a country can maintain at one time
- always moving towards potential
self correcting mechanism
prices are fully flexible in the LR
Prices/wages will adjust
In the LR classical model
- markets will clear
- thus there is no cyclical unemployment
- prices are fully flexible
Diminishing Returns to Labor
- less gain from specialization
- less resources for additional workers to use
Leakages
Taxes (T)
Savings (S)
Imports (IM)
Injections
Investment (Ip)
Government Spending (G)
Exports (X)
Household Savings formula
Disposable Income - Consumption spending
(Y-T)- C
Business Investment Ip formula
I- ∆inventories
Loanable funds market
determines interest rate
- real interest rate vs funds
- guarantees that demand of funds will equal supply of funds
Supply of funds
Households savings
- depends on income and interest
- S + (IM-X)
equals demand of funds
(market clearing assumption)
Demand of Funds
Used to finance investment spending
- depends on firms optimism about the future and interest
- lower interest rate, more demand for funds
- cheaper to pay back
- Ip + (G-T)
equals supply of funds
(market clearing assumption)
Total Spending formula
C + Ip + G
Role of interest rate
excess supply
- interest falls
excess demand
- interest rises
Fiscal Policy in the Classical model
change in G or T to ∆Y
- has no demand side effects
- due to crowding out (G to private sector)
- no impact on Y
- Fiscal policy is ineffective and unnecessary
Crowding out
decline in one sectors spending due to increase in another
- govt vs private
complete crowding out
dollar for dollar decline in one sectors spending to to an increase in another's
- rise in G
- Ip falls
- C falls crowd out
- decrease in T
- C rises
- Ip falls crowd out
If the deficit increases in the classical model?
caused by rise in G or fall in T
- demand for funds increases
- Interest rises
- Ip + C fall
How is the PL determined in the classical model?
By the supply and demand for money!
- in the LR, prices adjust to where MS=MD
- in the SR, a ∆ in MS results in ∆ PL
Demand for money MD
amount of money people want to hold
- some percentage of income
- MD= kPY
- PY= nominal income
- P= (1/kY) M
Supply of Money MS
determined by the Fed
- MS= M
- price level is proportionate
Quantity theory of money
used to explain the LR determinants of PL and inflation
- set MD = MS
Classical theory of inflation
Increase of quantity of money must either
- PL rises (inflation)
- or Y rises
- in classical model, this doesnt happen
- WAGES
Wages and PL
Increase in PL
- real Wages fall
Decrease in PL
- real Wages rise
Hyperinflation
inflation that exceeds 50% a month
About this deck
By: Miranda Heater
Created: 2011-04-27
Size: 34 flashcards
Views: 19
Created: 2011-04-27
Size: 34 flashcards
Views: 19
About StudyBlue
STUDYBLUE makes things that make you better at school.
Things like online flashcards with photos and audio.
Things like personalized quizzes and friendly reminders about when (and what) to study next.
Think of it as a digital backpack™: access to all of your study materials online and on your phone.
STUDYBLUE exists to make studying efficient and effective for every student, for free. Join us.
“I have used this website for three exams, and I see a huge difference in my test results.”
Naj
Naj