IMG2 - I Econ. 102. Chapter 3: Classical Theory: The...

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I Econ. 102. Chapter 3: Classical Theory: The Economy in the Long-run 1. To understand macroeconomic performance of the economy, economists divide all the variables that describe macroeconomic performance into real variables and nominal variables: Real variables: RGDP, the real wage rate, the real interest rate, the level of employment and unemployment, etc. Nominal variables: GDP, CPI, the money wage rate, the nominal interest rate, inflation rate, supply of money, etc. 2.The real variables describe the real economy and tell us what is really happening to production, consumption (C ), saving (S), investment (I), work and leisure, all of which contribute to the standard of living. 3. The nominal variables describe the nominal economy and tell us how dollar values and. the cost of living are changing. 4. The separation of macroeconomic performance into arealpart and a nominal part is the basis of huge discovery called the classical dichotomy, which states When the economy is operating at full employment, the forces that determine the real variables are independent of those that determine the nominal variables. Before Kelmes's general theory (1936), this is the basic classical macroeconomic theory that is now called the long-run macroeconomic theory. For example, J S Mill pointed out thht "money is a veif'. Modern economists call that money is neutral in the classical economy. 5. It should be noted that the classical dichotomy describes the economy atfull employmenf. But it does not hold over the business cycle as the economy fluctuates around the full employment. The forces that shape the real economy and those that shape the nominal economy interact to create the business cycle. {<******{. . Classical Theory: The Economy in the Long Run Long-run: A period of time in all endogenous variables are able to settle at their equilibrium and all economic processes have time to work in full. Assumptions: A1. A given time period. A2. Two inputs: K (Capital), L (labor) A3. The amount of inputs (resources) and technology is given. L:L,K: K. ,A.4. Production exhibits constant returns to scale. ,A'5. K and L are used fully and efficiently. 46. Perfect competition prevails. (Producers are price takers in the output and the input markets). A7. Consumers and producers make rational choice. A8. A closed economy.
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Real Economy. RGDP Recall there are two ways to view GDP: (i) the total income of everyone in the economy; (ii) total expenditure on the economy's output of goods and services. (1) Y
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This note was uploaded on 09/08/2010 for the course ECON 102 at San Jose State University .

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IMG2 - I Econ. 102. Chapter 3: Classical Theory: The...

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