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Economic Theory and Applications > Classical System > Flashcards

Classical System Flashcards

1
Q

What are the four basic elements of the classical system?

A
  1. Competitive and flexible labour markets, ensuring full employment
  2. Aggregate Demand for Say’s Law
  3. Theory of the price level derived from the quantity theory of money
  4. Law of diminishing return linking labour to the product market
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2
Q

When did the classical system dominate economic thinking?

A

From the 18th Century to the early 1930s.

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3
Q

Who are the two main classical scholars?

A

Adam Smith and David Ricardo

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4
Q

What are the two microeconomic assumptions of the classical system?

A

Perfect competition

Rational behaviour

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5
Q

What is Say’s law? What insight does this provide?

A

Say’s law states that the production of goods creates its own demand.
It suggests that the key to economic growth is to expand production rather than demand.

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6
Q

How does Say’s Law relate to financial institutions?

A

Any leakages of demand by monetary hoarding are reinjected by financial institutions

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7
Q

Why does Say’s Law not work in a monetary economy? What alleviates this?

A

Money can be used as a store of value, creating a glut. Banks can help this situation.

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8
Q

What is the equation for the quantity theory of money?

A

Mv = pY

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9
Q

What is Mv in the quantity theory of money equation?

A

Quantity of money needed in circulation to handle a given volume of transactions v

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10
Q

What is pY in the quantity theory of money equation?

A

Nominal value of output (GDP)

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11
Q

What determines Y in the quantity theory of money?

A

Y is determined by the production function and the labour market

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12
Q

Why is the quantity theory of money invalid?

A

The theory assumed that the central bank can control the money supply (M). It can’t.

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13
Q

What are the two main assumptions of the classical labour market?

A

All workers are the same in terms of skills

Workers do not suffer from money illusion (understand inflation)

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14
Q

What is the classical view on involuntary unemployment?

A

It doesn’t exist so long as wages remain flexible.

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15
Q

When real wages (W/p) rise, what do the substitution effect and income effect do?

A

Substitution effect causes the worker to work more when W/p rises.

Income effect causes worker to work less when W/p rises.

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16
Q

What does the quantity theory of money imply about the price level?

A

Suggests that the price level is determiend by the money supply p = f(M)

17
Q

What happens in the classical labour market when there is a surplus of labour?

A

Firms cut the wage, moving the supply curve down to drive out supply

18
Q

What happens in the classical labour market when there is a shortage of labour?

A

Firms offer a higher real wage, moving the supply curve up

19
Q

What is the key assumptions of the classical labour market which may not be true?

A

Satisfaction from each unit of leisure = satisfaction of goods bought from wages

20
Q

What two elements of the quantity theory of money stay the same?

A

v is constant and Y is given

21
Q

Why does Ns slope up on the classical labour market diagram?

A

The higher the wage, the more work will be delivered

22
Q

When does Nd shift on the classical labour market diagram?

A

Shifts when technological progress occurs which boosts productivity

23
Q

When does the Ns curve on the classical labour market diagram shift?

A

Shifts when there is a change in population

24
Q

Why does the curve for the production function flatten?

A

Workers are limited to working with a fixed amount of capital and marginal product of labour.

25
Q

What shifts the curve of the production function upwards?

A

If capital (K) and technology (T) rise in the long term

26
Q

Draw the model for the quantity theory of money

A

ok.

27
Q

What is the relationshiop between Y and P?

A

The relationship is inverse

28
Q

Explain the process of combining the classical labour market and the production function

A

The employment level from the labour market equilbirium determines the level of output from the production function

29
Q

Draw the production function

A

ok.

30
Q

Draw the classical labour market

A

ok.

31
Q

Draw the classical AD/AS diagram

A

ok.

32
Q

What does AD come from in the classical AD/AS diagram?

A

AD = Mv from the quantity theory of money

33
Q

Whats shifts AD on the classical AD/AD diagram?

A

Shifts when M or v changes. When the money supply increases the AD curve shifts the right, when it decreases it shifted to the left.

34
Q

What shifts AS on the AD/AS curve?

A

Shifts right when tech progress is made, capital stock or population increases. Vice-versa

35
Q

Draw the nominal wages diagram

A

ok.

36
Q

Draw the loanable funds market diagram

A

ok.

Economic Theory and Applications (3 decks)

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