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Unformatted text preview: Classical/Neoclassical Model Classical/Neoclassical Model Graduate Macroeconomics I ECON 309  Cunningham A Simple Neoclassical Model A Simple Neoclassical Model Assumptions Assumptions Market economy with private property. Markets are fully competitive. All variables in the model are either endogenous, or exogenous and supplied. Initially, there is no government. Except when indicated, the general equilibrium assumptions obtain. Two kinds of individual agents exist in this economy — firms and households. Agents Agents FIRMS:  produce commodities supply the commodities at the market price demand labor, paying the market wage undertake investment HOUSEHOLDS: Consume (purchase) commodities (at market prices) Supply labor at a wage Save Neoclassical Model Neoclassical Model , Continued , Continued No agent suffers “money illusion;” therefore, the analysis is real, with the “price level” determined separately from the “relative prices.” Firms and households are each homogeneous. Therefore, we collapse the analysis to that of a single “representative firm” and a “representative household,” and aggregate to form the firm and household sectors. The commodities are also homogeneous, so that we consider a single commodity whose real quantity is “ Y .” (Usually, we use “ y ” for real output, and “ Y ” for nominal. Therefore, the price of the commodity is the price level, “ P .” There are three (3) markets in this economy: Commodity Market Labor Market Capital Market (Loanable Funds or Bond Market) Neoclassical Model Neoclassical Model , Continued , Continued The nominal wage is “ w ,” and the real wage is therefore “ w/P .” The rate of interest (the price of capital) is “ r .” (The convention is to use “ i ” for the nominal interest rate and “ r ” for the real interest rate. There are three factors of production— capital ( K ), labor ( N ), and land ( L ). These factors are perfectly homogeneous. E.g., all workers look the same (have the same productivity and skills). At times, we assume that some of these factors, L and sometimes K , are fixed. That is, K=K and L=L . This leads to Y = AF(K,L ,N) = AF(K,N) = F(K,N) = AF(K ,L ,N) = AF(N) = F(N) Neoclassical Model Neoclassical Model , Continued , Continued Firms are technically efficient. That is, they produce the maximum output possible from the factors. Diminishing returns apply to production. Mathematically, this is equivalent to: , K F N F ∂ ∂ ∂ ∂ , 2 2 2 2 < < K F N F ∂ ∂ ∂ ∂ 2 2 = = N K F K N F ∂ ∂ ∂ ∂ ∂ ∂ Positive marginal returns to labor and capital....
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This note was uploaded on 02/25/2012 for the course CHEM 309 taught by Professor Staff during the Spring '11 term at UConn.
 Spring '11
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