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EQULIBRIUMGDP - EQULIBRIUM GDP AGGREGATE DEMAND(AD =...

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EQULIBRIUM GDP: AGGREGATE DEMAND (AD) = AGGREGATE SUPPLY (AS) THE CLASSICAL ECONOMIC SYSTEM The centerpiece of classical economics is Say’s Law – J.B Say (18 th century) - Say’s law states that supply creates its own demand. What we produce supply all gets sold. Ricardo’s elaboration of Say’s Law. People produce they get paid money spend it what others produce. Question: “Why does anybody work?” asked Say. To make money with which to buy things . As long as everyone spends everything that he or she earns, we’re o.k. Basically, producers need to sell everything they produce. Assuming no saving consumption or demand production lay off unemployment. If savings = D we’d never have unemployment However, saving is crucial to economic growth: No S No I Consumer goods - C Production → Ignoring G Investment goods – I GDP = C+I GDP = C+S Think of GDP as income received (C+S) C+S = C+I S = I a) This is a perfect economic system b) Everything produced is sold c) Everyone who wants to work can find a job d) No business cycles e) No government intervention SUPPLY AND DEMAND REVISITED Equilibrium or market clearing price and quantity Q P D S Q e P e
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Classical economists Application of the law of supply and demand to prove Say’s Law More specifically – that S=I S > I unemployment Classical economists No worry, why? r↓ - if this is not achieved, then both price and wage flexibility would bring about equilibrium between S and I. Note: S > I C↓ D↓ P↓ firms will cut P (↓) to sell more and if wages↓, profits could actually be realized. THE CLASSICAL EQUILIBRIUM; AGGREGATE DEMAND EQUALS AGGREGATE SUPPLY Micro Level: Q d = Q s Equilibrium is the state of rest – no tendency for a ∆ Macro Level: AD = AS The classical economists believed the economy was either at, or tending toward, full employment. So at the classical equilibrium, the GDP at which AD equals AS, was at full employment. The Aggregate Demand Curve Total expenditures by the community on goods and services. By implication therefore the components are households demand (C), Business demand (I), and government demand (G). The AD curve gives the various levels of real GDP that will be demanded at various price levels, ceteris paribus. Like most demand curves, the AD curve slopes downward. Interest rate Investment (I) Saving (S) Q L r e I & S
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Explanations for the shape of the AD curve 1) Wealth Effect An increase in the P level reduces the wealth of people holding money, making them feel poorer and reducing their purchases. P↑ levels consumers, businesses a government will cut on autonomous consumption spending. The C+I+G curve shift downward.
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