Classical Approach Flashcards
What does consumption depend on in CA?
Directly on DI
C = C(DI) = C(Y-T)
2 assumptions regarding C = C(Y-T) in CA?
Tax does not depend on income
Consumption only depends on DI and NOT the interest rate
Define marginal propensity to consume?
The change in consumption resulting from a change in disposable income
(Slope of consumption function)
What does investment depend on in CA?
The interest rate
I = I(r)
What is the real interest rate (r)?
The nominal interest rate(i) adjusted for inflation
Draw I(r) diagram?
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Draw GPL against output diagram?
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What does it mean to have an exogenous variable in economics and how is it represented?
It means it comes from outside the model and is unexplained by it tf taken as fixed
Given by a line above the variable
Define AD?
The total demand for all final goods and services in the economy
Why does the AD curve slope down?
When general price level is higher, wages increase tf less output
3 main assumptions of classical approach idea?
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
When will an employer employ til if capital is fixed?
MR(L) = MC(L)
Define real wage?
The wage in terms of the amount of G+S that can be bought
Draw supply and demand of labour diagram for entire economy, and explain how equilibrium is restored if the price level increases or decreases?
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How is the real wage determined in the CA?
It is determined by the point where quantity of labour supplied = quantity of labour demanded
Assumes whoever wants work can find employment
Define AS?
The total quantity of final goods and services suppliers are willing and able to supply at a given price level
Why is the supply of labour curve vertical in CA?
Assumes labour force doesn’t depend on the real wage
Why is the output in the economy considered fixed in CA?
Supplies of L and K are fixed tf and Y=F(L,K) (all with lines above)
Why is the AS curve vertical?
Labour is independent of price and so is Y
Draw classical macroeconomic equilibrium diagram?
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Define loanable funds market?
The market in which those who want to save supply funds, and those who want to borrow to invest demand funds
Interest rate = ?
Return in saving = cost of borrowing
Real interest rate vs saving diagram?
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Assumption regarding C and i, and how this shows S is fixed?
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
Learn diagram for r against saving/investment and explain how it stays in equilibrium?
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Explain why saving doesn’t depend on r?
assumption of vertical supply of savings curve means S is fixed tf change in r doesn’t affect it
How does the interest rate adjust?
It adjusts until amount firms want to invest = amount households want to save
Show that Y=C+I(r)+G
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How do changes in FP affect supply of loanable funds?
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
Define expansionary FP?
An increase in G or a fall in T for a given price level
What is the crowding out effect?
When EFP -> increase r -> fall investment
Name a couple of other factors that affect the investment level IN REALITY?
Corporate tax level
R+D level
What happens in the CA if the government increase household tax and decrease corporate tax by the same amount?
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)
See end of L4
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