Chapter 7 - Chapter 7 Classical model A macroeconomic model...

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Chapter 7 Classical model - A macroeconomic model that explains the long-run behavior of the economy - Over periods of several years or longer, the economy performs rather well - Business cycles may come and go, but the economy eventually returns to full employment - Powerful forces are at work that drive the economy toward full employment - Important for two reasons 1. There has been an active counterrevolution against Keynes’s approach, new theories are just classical economics in modern clothing 2. Useful in understanding the economy over the long run - Classical model has proven more useful in explaining the long-run trend itself - Assumptions of classical model Markets clear: the price in every market will adjust until quantity supplied and quantities demanded are equal Keynesian - Keynes’s idea and their further development help us understand economic fluctuations – movements in output around its long-run trend. The labor market
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- Number of workers is measured on the horizontal axis - Real hourly wage rate is measured on the vertical axis - Labor supply curve (L S ): indicates how many people will want to work at various real wage rates - Labor supply curve slopes upward because as the wage rate increases, more and more individuals are better off working than not working. Thus, a rise in the wage rate increases the number of people in economy who want to work – to supply heir labor - Labor demand curve (L D ): indicates how many workers firms will want to hire at various real wage rates. - As wage rate increases, each firm in the economy will find that, to maximize profit, it should employ few workers than before. When all firms behave this way together, a rise in the wage rate will decrease the quantity of labor demanded in the economy - Labor is fully employed at equilibrium level - In the classical view, the economy achieves full employment on its own Economy’s output - Economy’s output depends on 1. The amount of other resources available for labor to use 2. The state of technology, which determines how much output we can produce with those resources - Aggregate production function
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