Ch07_macro

Ch07_macro - Chapter 7: At Full Employment: The Classical...

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1 Chapter 7: At Full Employment: The Classical Model Objectives: Explain the purpose of the classical model Describe the relationship between the quantity of labor employed and real GDP Explain what determines the full-employment level of employment and real wage rate and potential GDP Explain what determines unemployment when the economy is at full employment Explain how borrowing and lending decisions interact to determine the real interest rate, saving, and investment Apply the classical model to explain changes and international differences in potential GDP and the standard of living
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The Classical Model: A Preview To understand macroeconomic performance, economists distinguish between real variables and nominal variables. Real variables: economic well-being Real GDP, employment and unemployment, the real wage rate, consumption, saving, investment, and the real interest rate. Nominal variables: dollar values The price level, the inflation rate, nominal GDP, nominal wage rate, and the nominal interest rate.
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The Classical Model: A Preview The separation of macroeconomic performance into a real part and a nominal part is the basis of the classical dichotomy. The classical dichotomy states: At full employment, the forces that determine real variables are independent of those that determine nominal variables. The classical model is a model of an economy that determines the real variables.
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Real GDP and Employment To produce more real GDP, we must use more labor or more capital or develop technologies that are more productive. It takes time to change the quantity of capital and develop new technologies, so to change real GDP quickly, we must change the quantity of labor. So, what is the relationship between the quantity of labor employed and real GDP?
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Real GDP and Employment Production Possibilities (PPF) The boundary between those combinations of goods and services that can be produced and those that cannot. To study the relationship between the quantity of labor employed and real GDP, we begin with a special PPF : one that shows the boundary between leisure and real GDP.
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Time can be allocated to leisure or to labor, which produces real GDP. The more leisure time forgone, the greater is the quantity of labor employed and the greater is the real GDP. Real GDP and Employment
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When 250 billion hours of leisure are taken and 200 billion hours allocated to labor, real GDP produced is $12 trillion. Real GDP and Employment
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Real GDP and Employment The Production Function The production function is the relationship between real GDP and the quantity of labor employed, other things remaining the same (e.g., capital). 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 .
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function, an increase in labor hours brings an increase in real GDP. Real GDP and Employment
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Ch07_macro - Chapter 7: At Full Employment: The Classical...

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