The classical model was a term coined by Keynes in the 1930s to represent basically all the ideas of economics as they apply to the macroeconomy starting with Adam Smith in the 1700s all the way up to the writings of Arthur Pigou in the 1930s.

D) larger; larger the supply of money. E) larger; smaller the supply of money 54) All else the same, when real GDP increases, the. A) demand for money decreases. B) demand for money increases. C) supply of money decreases. D) supply of money increases. E) supply of money does not change, and the demand for money does not change. 1.The axes of the goods market-money market graph in Chapter 12 (the IS-LM graph) are real GDP or income on the horizontal axis and the interest rate on the vertical axis. TRUE 2.An increase in the money supply will lead to a shift down and to the right of the money-market (LM) curve. Oct 08, 2020 Monetary distortions of GDP in 2021. This article explains the effect of monetary inflation on GDP. Nominal GDP is directly inflated by additional money and credit, so GDP growth is simply a reflection of additional money in the economy. It gives no clue as to the underlying economic situation. Large part of real GDP, yet it accounts for a small share of the fluctuation in real GDP. The classical dichotomy refers to the separate of. The real rate of interest and the money supply c. Government expenditures and taxes d. The saving rate and net exports.

In this chapter I will describe the main characteristics of what we now call the classical model and how the macroeconomic variables are determined in this model. As discussed in the previous section, we focus on the cycles and all the components included in the GDP (consumption, investment, imports and exports) are variables where the trend has been removed.

The classical model in this chapter will not discuss the determination of the exchange rate. In chapter 16 we will look at an extension of the classical model which will also include the exchange rate.

Labor Market

We begin by describing the classical model of the labor market.

Demand for labor

The demand for labor LD is assumed to be inversely related to the real wage W/P

Profit-maximizing firms will want to employ labor up to the point where the marginal product of labor MPL is equal to the real wage W/P. We have previously assumed that MPL is decreasing in L and the demand for labor can be illustrated in the following graph.

Fig. 10.1: The demand for labor.

From the graph you can conclude that the aggregate demand for labor, or just the demand for labor depends on the real wage. If the real wage increases, the demand for labor decreases and vice versa. For example, the demand for labor will fall if W increases and/or if P decreases but it will not change if W and P increase by the same percentage.

In the classical model, markets are characterized by perfect competition and the firms cannot affect W and P. However, they do decide how much labor to hire. If you sum all the labor that firms want to hire you to get the total demand for labor.

The supply of labor

The supply of labour LS is assumed to be positively related to the real wage W/P

The total labor supply is determined by utility-maximizing individuals. The total labor supply is also affected by the real wage. An increase in the real wage has two effects:

Income Effect: With a higher income, individuals will want to consume more leisure (as long as leisure is a normal good). Higher real wages will lead to lower labor supply.
Substitution Effect: A higher real wage will make leisure relatively more expensive, causing individuals to substitute leisure for consumption. Higher real wages will lead to higher labor supply.

The overall effect of a change in real wages is the sum of the income and substitution effects. For some individuals, the substitution effect will be stronger than the income effect and they will increase the labor supply as the real wage increases and for some it will be the opposite. In the classical model it is always assumed that the aggregate labor supply increases when real wages increase (the substitution effect is stronger than the income effect).

Equilibrium in the labor market

Real wage W/P will be equal to the equilibrium real wage in the classical model

Without government intervention and trade unions, the labor market will always be in equilibrium in the classical model. This means that the real wage will be equal to the equilibrium real wage – the level of real wage which will equilibrate the labor demand and the labor supply.

Fig. 10.2: Equilibrium in the labor market.

It is also clear from the graph that the total amount of labor L is determined in the labor market. When the real wage is equal to the equilibrium real wage, the supply of labor is equal to the demand for labor and this is the amount that will be used in the production. We then have full employment (see Wages and income).

If real wages are higher than the equilibrium real wage, the demand for labor will be less than the supply. The difference is the amount of unemployment beyond the natural rate of unemployment. In equilibrium, there is therefore no 'involuntary' unemployment in the classical model.

GDP, and Say's Law

The larger real gdp the supply of money per

Aggregate supply

YS = f(L, K) in the classical model where

L is determined in the labor market while K is exogenous

The aggregate supply YS is defined as the amount of finished goods and services firms in a country will want to sell under given conditions. In the classical model the aggregate supply is determined by production function, YS = f(L, K).

The amount of capital in the classical model is an exogenous variable; it is not determined within the model but assumed to be given. Although we typically assume that K is constant – which is reasonable in the short run – it need not be constant. K may increase over time, but we must know K at any point in time.

The amount of labor, however, is an endogenous variable that is determined in the labor market. This means that YS is determined entirely by the labor market in the classical model. The following chart illustrates.

Fig. 10.3: Determination of aggregate supply.

Aggregate demand and Say's Law

YD = YS in the classical model (Say’s law)

The aggregate demand YD is defined as the quantity of nationally produced finished goods and services that consumers, government and the rest of the world want to buy under given conditions.

One of the key elements of the classical model is Say's Law. According to Say's Law the aggregate demand is always equal to the aggregate supply: YD = YS.

Say's Law is sometimes stated as 'supply crea

The Larger Real Gdp The Supply Of Money