ec-4 - Chapter 11 Classical vs Keynesian Short Run...

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Classical vs. Keynesian & Short Run Aggregate Supply Chapter 11
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The Classical Model: Long Run Keynesian Model: Short Run Aggregate Supply Short Run & Long Run Equilibrium Determinates of Long Run & Short Run Aggregate Supply Changes in Long Run & Short Run Equilibrium: Two Gaps Chapter Outline
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The Classical Model: Long Run The classical model was the first attempt to explain fluctuations in: Inflation Output Income Employment Consumption Saving Investment
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The Classical Model: Long Run Say’s Law Supply creates its own demand Producing goods and services generates the means and the willingness to purchase other goods and services
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The Classical Model: Long Run Assumptions of the classical model Pure competition exists No one can individually influence the market place **Wages and prices are flexible People are motivated by self-interest People cannot be fooled by money illusion (inflation)
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The Classical Model: Long Run Consequences of the assumptions Minimize the role of government in the economy If all prices and wages are flexible, any problems in the macroeconomy will be temporary The power of the market will keep the economy at full employment in the long run
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The Classical Model: Long Run Observations Equilibrium always at full employment Long run Say’s Law Flexible AS = LRAS LRAS located at *full-employment Real GDP per Year Price Level Y 0 LRAS
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The Classical Model: Long Run Observations Initial equilibrium at P = 0 and Y 0 Real GDP per Year Price Level Y 0 LRAS
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The Classical Model: Long Run with Increases in Aggregate Demand Observations Increase in AD creates disequilibrium Quantity AD ( Y 1 ) > Quantity AS (Y 0 ) Real GDP per Year Price Level Y 0 LRAS Y 1 A 1 AD 1 AD 2
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