Ch 07 - C h a p t e r 7: A t Fu l l E m p l o ymen t : T h...

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C h a p t e r   7:   A t   F u l l   E m p l o y m e n t :   T h e   C l a s s i c a l  M o d e l I. The Classical Model: A Preview The Classical Model is introduced. 1. There are two distinct categories of variables that describe macroeconomic performance: a) Real variables: real GDP, employment and unemployment, the real wage rate, consumption, saving, investment, and the real interest rate. b) Nominal variables: the price level (CPI or GDP deflator), the inflation rate, nominal GDP, the nominal wage rate, and the nominal interest rate. 2. The separation of macroeconomic performance into a real part and a nominal part is the basis of the classical dichotomy. 3. The classical dichotomy  states: “At full employment, the forces that determine real variables are independent of those that determine nominal variables.” 4. The classical model  is a model of the economy that determines the real variables at full employment. 5. Most economists believe that the economy fluctuates around full employment, but that the classical model provides powerful insights into the level of full employment and potential GDP around which the economy fluctuates. II. Real GDP and Employment A. Production Possibilities 1. The production possibilities frontier ( PPF ) is the boundary between those combinations of goods and services that can be produced and those that cannot. 2. Figure 7.1 (a) illustrates a production possibilities frontier between leisure time and real GDP. 3. The more leisure time forgone, the greater is the quantity of labor employed and the greater is the real GDP. 4. The PPF showing the relationship between leisure time and real GDP is bowed-out, which indicates an increasing opportunity cost: As real GDP increases, each additional unit of real GDP costs an increasing amount of forgone leisure. 5. Opportunity cost is increasing because the most productive labor is used first and as more labor is used, the labor used becomes increasingly less productive. B. The Production Function 1. The production function  is the relationship between real GDP and the quantity of labor employed when all other influences on production remain the same. 2. One more hour of labor employed means one less hour of leisure, therefore the production function is the mirror image of the leisure time-real GDP PPF . 3. Figure 7.1 (b) illustrates the production function that corresponds to the PPF shown in Figure 7.1 (a). III. The Labor Market and Potential GDP
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A. The Demand for Labor 1. The quantity of labor demanded is the labor hours hired by all the firms in the economy. 2. The demand for labor ,   Figure 7.2, is the relationship between the quantity of labor demanded and the real wage rate when all other influences on firms’ hiring plans remain the same. 3.
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This note was uploaded on 04/03/2009 for the course ECON 2101 taught by Professor Bill during the Spring '09 term at Temple.

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Ch 07 - C h a p t e r 7: A t Fu l l E m p l o ymen t : T h...

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