The Classical Model

The Classical Model - Econ 1021 Fall 2009

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The Classical Model  of the Macroeconomy Outline 1. Introduction 2. The labor market  3. The loanable funds market 4. 5. Business cycles in the classical model 6. Public policy implications Econ 1021 Fall 2009 Reading:   pp. 158-162, 212-215, 239-244, 314-15, and  323-324 from  Macroeconomics in Context
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Introduction – a brief “road map” 1. Consider the equilibrium conditions further – what must  be true so that leakages are exactly equal to injections? a) Role of the labor market b) Role of loanable funds market  c) How does fiscal policy affect the macroeconomy – the classical  framework 2. Explaining cyclical unemployment – the Keynesian  model. 3. 4. 5. Open Economy macroeconomics
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Introduction – general questions business cycle – raise 2 basic questions: 1. What are the underlying causes of the business  cycle?  (goal:  match “stylized facts” to develop a  theory of the business cycle ) 2. What, if anything, should government policy-makers  do about business cycles
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Business Cycle Theory A complete theory of the business cycle must  have 2 components: 1. A description of the types of shocks or disturbances  believed to affect the macroeconomy the most a) “Real” vs “Nominal” shocks Real:  productivity (supply side); changes labor supply, C, I, G,  NX…  Nominal: changes to money demand or supply 2. A description of how key macro-variables (Y,  employment, “prices”) respond to economic shocks.
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“Classical” interpretation D labor  =  ( w MPL,  other stuff not covered in 1021 ) S labor  =  ( w wealth w e , adult pop., particip rate) Real Wage ( w  =W/P) Quantity of labor w * L*   (+)  (-)      (-)      (+)             (+)   (-)  (+)  next slide… 1. Equilibrium L* implies that Y = Y*  -- there is no involuntary unemployment 2. Changes in demand or supply of labor   change equilibrium L* (and  w *)    change Y*
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Production function… Y Total product Quantity of labor Y = TP ‘diminishing marginal productivity’:  increases in L lead to increases in Y; but additional units of L lead to smaller and smaller increases in Y
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The demand side of the macro ‘goods’  market:  the classical interpretation Suppose, for now, that Y* isn’t changing. Given a level of real GDP (Y*), what ensures 
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This note was uploaded on 12/03/2010 for the course ECON 1021 taught by Professor Lang during the Spring '10 term at UChicago.

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The Classical Model - Econ 1021 Fall 2009

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