Assumptions of Classical Macroeconomics Theory, Slides of Economics

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WHAT ARE THE MAIN

ASSUMPTIONS

UNDERLYING THE

CLASSICAL

MACROECONOMICS

THEORY?

ASSUMPTIONS OFASSUMPTIONS OF

CLASSICAL CLASSICAL

MACROECONOMICS MACROECONOMICS

2.2. LABOR MARKETLABOR MARKET

Flexibility of the wage rate keeps the labor market in equilibrium. Supply exceeds demand, pay to workers will fall. Willing to be paid at lower wages. Any unemployment = voluntary unemployment  (^) Refuse to accept lower wages

Equilibrium Levels ofEquilibrium Levels of Employment Employment

Autonomous Decline inAutonomous Decline in Investment Demand Investment Demand

Economy agents behave rationally. All agents produce quality outputs (no bad products in the market). No monopoly market occur. Economy not suffering from ‘money illusion’. People consume depends on real prices instead of nominal prices.

4. Economy Run Rationally

Real output (Y) AS AD Price (P)

---

**Y 

P E**

Economy in equilibrium at full employment level in long run. All people will gain job. It achieved and maintained without the need for government intervention.

6. Economy in equilibrium

“THE AGGREGATE

DEMAND CURVE IN THE

CLASSICAL IS RELATED

TO THE QUANTITY

THEORY OF MONEY.”

EXPLAIN.

Classical Aggregate DemandClassical Aggregate Demand (AD) (AD)

Classical Quantity Theory ofClassical Quantity Theory of Money Money

MV = PY

where, M = Money Supply V = Velocity of Money P = Aggregate Price Y = Real GDP / Output

Relationship between P and YRelationship between P and Y

Relationship between M and PRelationship between M and P

MV = PY

• As M increases, P increases.
• As M decreases, P decreases.

Aggregate Demand CurveAggregate Demand Curve Y Real GDP M AD AD AS M1V M2V