Classical Solution Illustrated

Classical Solution Illustrated - worried that this may...

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Classical Solution Illustrated: The classical solution to overcome temporary and marginal gaps between demand and supply: forces is in the form of flexible wage rates and flexible prices . This can be illustrated. At the macro level of economic operations the prices include a variety of prices of goods and services, wage rates, interest rates, rent of land etc. Let’s therefore illustrate it with the movements in the rate of interest. This should however be treated as of symbolic importance. What is true about rate of interest is equally true under the classical system about wage rates of all other prices. Let’s assume that for some reason the consumers decide not to spend the whole of their income. This would cause a fall in the demand. With such a shrinking in the consumers’ aggregate demand all the goods and services offered for sale in the market cannot be sold. In the market there would exist the condition of excess supply. The producers would be
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Unformatted text preview: worried that this may eventually cause a fall in the price level and thereby a fall in their profit margin. Therefore the firms would be inclined to restrict their production and reduce their particular demand for factor services. Hence an initial fall in the consumer’s demand ultimately results into the unemployment condition. But in view of self-equilibrating nature of the economic activities , at this point one can bring in the flexible price solution of the classical argument. We illustrate this with the help of a figure which shows the aggregate savings and aggregate investment curves. In this case with a fall in the aggregate demand for consumption goods, a compensating increase in investment expenditure takes place, with appropriate changes in the rate of interest....
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This note was uploaded on 11/17/2011 for the course EC ec 201 taught by Professor - during the Fall '10 term at Montgomery.

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Classical Solution Illustrated - worried that this may...

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