Classical macroeconomics focused on achieving full employment equilibrium. It viewed the economy as self-correcting through flexible wages and prices. According to classical thought, the free market could achieve equilibrium with everyone employed as long as the price of labor cleared the market. The quantity theory of money also held that the money supply determined aggregate demand and price levels in the long run.
Classical macroeconomics focused on achieving full employment equilibrium. It viewed the economy as self-correcting through flexible wages and prices. According to classical thought, the free market could achieve equilibrium with everyone employed as long as the price of labor cleared the market. The quantity theory of money also held that the money supply determined aggregate demand and price levels in the long run.
Classical macroeconomics focused on achieving full employment equilibrium. It viewed the economy as self-correcting through flexible wages and prices. According to classical thought, the free market could achieve equilibrium with everyone employed as long as the price of labor cleared the market. The quantity theory of money also held that the money supply determined aggregate demand and price levels in the long run.
Great Depression: “The General Theory of Employment, Interest and Money” by John Maynard Keynes, in 1936 → Revolution against Classical. Classical thought even taken by the Keynesians as scrape but actually it proves to be base for counter attack on Keynesians by Monetarist, New Classical and real business cycle theorists. Keynes considered all economists before 1936 as Classical but there also existed two broad categories: Classical; Adam Smith, David Ricardo, John Stuart Mill; &&&: Neoclassical; Alfred Marshal and A.C. Pigou. Classical Focus: Full employment (a point where actual output is just equal to potential output) and Equilibrium. 2. The Classical Revolution Classical itself is a revolution against Mercantilist (16 th & 17th Century) Principles of Mercantilist: Bullionism and State Action Bullionism: Collect gold through export orientation, export of gold was prohibited, colonialism Principles of Classical: Real factors (money as means of exchange) and Free Market Economy (Self adjusting tendencies) Classical thought are presented for explanation in the long-run, however, short run thinking could be extracted Mercantilist viewed money as a source of demand but Classical termed this role as dangerous Mercantilist emphasized 3. Production Y =F ( Ḱ , N ) Table: 1 Figure: 1 4. Employment Assumptions: Market works well, optimizing behavior, perfect information, flexible wages, market clear Labour Demand Individual firm i.e. ith firm, perfect competition, profit maximization, output depends upon labour hence choosing output is the basic decision for profit maximization Profit maximization decision of the ith firm is MC = MR MR = P MC of the firm is the marginal labour cost because labour is the only input & MCi = W/MPNi P = MCi ⇒ P = W/MPNi ⇒ MPNi =W/P Figure: 2 Downward sloping curve due to the law of diminishing returns MPN curve is the demand curve for labour: inverse relationship Demand for labour is the aggregation of demands of all individual Nd = f(W/P) : Negative relationship Labor Supply Individual Workers: Utility maximization Indifference curve analysis is helpful to understand Figure: 3 Ns = g(W/P) : Positive relationship Two important features of labour supply curve: Real wage Positive Slope (Income Effect, and Substitution Effect, Backward Bending labour suppy curve) Figure: 3 5. Equilibrium Output and Employment Ch. 2 Classical Macroeconomics: Money, Prices and Interest
Aggregate Price Level- the Demand Side of the Economy
1. The Quantity Theory of Money
Quantity of money determines aggregate demand which in turn determines price level The Equation of Exchange An identity relating volume of transactions ( T ) at current prices ( PT ) to the supply of money ( M ) times the turnover rate ( V T ) Turnover Rate: Average number of time each dollar is used in transactions during a certain time PT T period is called velocity of money i.e. VT= M The identity given by Irving Fisher is M V T =PT T [on the basis of definition of velocity of money] 3600 Example: VT= =12 300 This expression of exchange includes transactions of commodities produced in current time period as well as transactions related to goods produced in previous time period Another version of equation of exchange, which consider income ( Y ) and velocity of income ( V ) as the variables of equation, does not include goods and services produced in previous time period and includes only current output: V=PY/M ⇒ M V =PY This identity could be converted into equation if factors explaining velocity of money could be explained 2.