Long-Run Classical Model Flashcards
What determines output?
• Real forces of productivity, amount of capital (K), labor force (L), technology, and raw material cost
o Mainly supply, capital, and labor
What determines prices?
• Flexible wages and prices (money)
What determines interest rates?
• Supply and demand for loanable funds [same thing as S and I]
o Savings and investments determine real interest rates
What is the loanable funds theory?
• Loanable funds theory
(used in a classical market analysis to describe the supply, demand, and interest rates for loans in the market for loanable funds)
o Explains why saving equals investment in the long-run and why Say’s law always holds
What is Say’s law?
• Says law
(supply creates its own demand hence no unemployment)
o Except structural and frictional but no cyclical
What is the quantity theory?
• Quantity theory of money
(direct relationship between the quantity of money in an economy ad the level of prices of goods and services sold)
o Explains the role of money in the long-run classical model which is only to determine the price level and the nominal values
• MV=PY
What is the natural rate of unemployment (NAIRU)?
• NAIRU
(Non-Accelerating Inflation Rate of Unemployment)
o Specific level of unemp that exists in an economy that does not cause inflation to increase
• Natural rat of unemployment
o ‘full employment’ unemp rate there is structural and frictional but not cyclical
• Structural and frictional no cyclical
What is the relation between the nominal and real interest rates and inflation? (fisher’s equation)
• Nominal and Real interest rates
o Nominal interest rate is the percentage you pay the lender for the money borrowed
o Real interest rate is the percentage increase on purchasing power the lender receives when the borrower repays the loan with interest
• Inflations role
o Nominal interest rates do not take inflation into account, unadjusted for inflation
o Real interest rate is the actual percentage taking inflation into consideration
• Fisher’s equation
(provides the link between nominal and real interest rates)
o Real interest rate= nominal interest rate – inflation rate
What causes inflation in the long-run?
• Demand and Supply shocks self-limiting
o Prices up the stop, unless D continues to increase
• Increase in the money supply
o Printing money
What causes unemployment in the long-run?
• Natural rate of unemployment, so full employment
o Except structural or frictional
What is crowding out?
• Crowding out
(when gov must finance its spending with taxes and/or with deficit spending leaving business with less money and effectively ’crowding them out’)
o Government spending up and Investment down
How does fiscal policy affect the economy in the long-run?
- Leads to complete crowding out of investment (bad) and thus has no impact on agg D or anything else (other than I)
- It is not needed and not effective in the long-run
How does monetary policy affect the economy in the long-run?
- Only changes prices (and other nominal variables like the nominal interest rate, nominal wage rate, etc.)
- It is not useful or effective for stabilization in the long-run
What is the long-run Philips curve and what does it imply? What makes the short-run curve shift to the right?
• LR Phillips curve o Vertical curve o Implies no tradeoff between inflation and unemployment • SR Phillips curve o Shift cause by agg D increase
What role do inflationary expectations play in inflation and the Phillips curve?
• Inflationary expectations
(expectations that consumers have concerning future inflation)
o Expansionary efforts to decrease unemployment below the natural rate of unemployment will result in inflation
o Changes inflation expectations of workers, who adjust nominal wages to meet expectations of future
o Leading to a shift in the short-run Phillips curve
