Exam 3 Notes - Chapter 11 Classical Economist world of...

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Chapter 11 Classical Economist – world of fully utilized resources; no unused capacity and no unemployment; assumed that wages would always adjust to the full employment level Assumptions of Classical Model – 1. pure competition exists; 2. wages and prices are flexible; 3. people are motivated by self-interest; 4. people cannot be fooled by money illusion. Money illusion – reacting to changes in money prices rather than relative prices. If a worker whose wages double when the price level also doubles thinks he or she is better off, that worker is suffering from money illusion. Classical Model LRAS is vertical; won’t shift b/c of change in prices; determines output AD is downward sloping; changes in AD only change the price level (increase in AD=increase in price level; decrease in AD=decrease in price level; GDP is remains the same) Savings & Investment – when saving is introduced into the model, equilibrium occurs in the credit market through changes in the interest rate such that desired saving equals desired investment at the equilibrium rate of interest Demand-pull and cost-push inflation causes short-run variations in the inflation rate Say’s law – a dictum of economist J.B. Say that supply creates its own demand; hence it follows that desired expenditures will equal actual expenditures; producing goods and services generates the means and the willingness to purchase other goods and services Long-run aggregate supply and aggregate demand both decrease over time, but aggregate demand decreases faster than aggregate supply. The result would be lower real GDP and lower price level Keynesian Model SRAS – has one portion that is flat, and another that is upward-sloping; can be horizontal when wages and prices are completely flexible; relationship b/n total planned economywide production and the price level in the short run; changes in resource prices cause the SRAS curve to shift; if prices adjust incompletely in the short run, the curve is positively sloped; can be shifted b/c of weather that delays a shipment of steel causing steel prices to increase (can’t affect LRAS)
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This test prep was uploaded on 04/07/2008 for the course ECON 103 taught by Professor Downing during the Fall '06 term at Danville Area CC.

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Exam 3 Notes - Chapter 11 Classical Economist world of...

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