Classical Approach

Question 1

What does consumption depend on in CA?

Answer 1

Directly on DI

C = C(DI) = C(Y-T)

Question 2

2 assumptions regarding C = C(Y-T) in CA?

Answer 2

Tax does not depend on income

Consumption only depends on DI and NOT the interest rate

Question 3

Define marginal propensity to consume?

Answer 3

The change in consumption resulting from a change in disposable income

(Slope of consumption function)

Question 4

What does investment depend on in CA?

Answer 4

The interest rate

I = I(r)

Question 5

What is the real interest rate (r)?

Answer 5

The nominal interest rate(i) adjusted for inflation

Question 6

Draw I(r) diagram?

Answer 6

Now

Question 7

Draw GPL against output diagram?

Answer 7

Now

Question 8

What does it mean to have an exogenous variable in economics and how is it represented?

Answer 8

It means it comes from outside the model and is unexplained by it tf taken as fixed

Given by a line above the variable

Question 9

Define AD?

Answer 9

The total demand for all final goods and services in the economy

Question 10

Why does the AD curve slope down?

Answer 10

When general price level is higher, wages increase tf less output

Question 11

3 main assumptions of classical approach idea?

Answer 11

All economic agents are rational and aim to maximise their benefit

All markets are perfectly competitive

All agents have perfect knowledge of market conditions and prices

Question 12

When will an employer employ til if capital is fixed?

Answer 12

MR(L) = MC(L)

Question 13

Define real wage?

Answer 13

The wage in terms of the amount of G+S that can be bought

Question 14

Draw supply and demand of labour diagram for entire economy, and explain how equilibrium is restored if the price level increases or decreases?

Answer 14

Now

Question 15

How is the real wage determined in the CA?

Answer 15

It is determined by the point where quantity of labour supplied = quantity of labour demanded

Assumes whoever wants work can find employment

Question 16

Define AS?

Answer 16

The total quantity of final goods and services suppliers are willing and able to supply at a given price level

Question 17

Why is the supply of labour curve vertical in CA?

Answer 17

Assumes labour force doesn’t depend on the real wage

Question 18

Why is the output in the economy considered fixed in CA?

Answer 18

Supplies of L and K are fixed tf and Y=F(L,K) (all with lines above)

Question 19

Why is the AS curve vertical?

Answer 19

Labour is independent of price and so is Y

Question 20

Draw classical macroeconomic equilibrium diagram?

Answer 20

Now

Question 21

Define loanable funds market?

Answer 21

The market in which those who want to save supply funds, and those who want to borrow to invest demand funds

Question 22

Interest rate = ?

Answer 22

Return in saving = cost of borrowing

Question 23

Real interest rate vs saving diagram?

Answer 23

Now

Question 24

Assumption regarding C and i, and how this shows S is fixed?

Answer 24

C does not depend on i

Tf S=Y-C-G
Y is fixed
C depends on Y and T, both fixed tf C fixed
G is fixed
Tf S is fixed too

Question 25

Learn diagram for r against saving/investment and explain how it stays in equilibrium?

Answer 25

Now

Question 26

Explain why saving doesn’t depend on r?

Answer 26

assumption of vertical supply of savings curve means S is fixed tf change in r doesn’t affect it

Question 27

How does the interest rate adjust?

Answer 27

It adjusts until amount firms want to invest = amount households want to save

Question 28

Show that Y=C+I(r)+G

Answer 28

Now

Question 29

How do changes in FP affect supply of loanable funds?

Answer 29

Increase in G means fall in S tf supply of loanable funds shifts left tf increase in real rate of interest
Vice versa

Increase in T means fall in C tf increase in saving tf supply of loanable funds shifts right tf decrease in r

Question 30

Define expansionary FP?

Answer 30

An increase in G or a fall in T for a given price level

Question 31

What is the crowding out effect?

Answer 31

When EFP -> increase r -> fall investment

Question 32

Name a couple of other factors that affect the investment level IN REALITY?

Answer 32

Corporate tax level

R+D level

Question 33

What happens in the CA if the government increase household tax and decrease corporate tax by the same amount?

Answer 33

Higher investment (increased profitability) BUT no change in total tax tf no change in saving tf increased r while leaving total investment the same (SEE AND LEARN DIAGRAM)

Question 34

See end of L4

Answer 34

Now