Macro Economics Essays - Economics, Economy, Demand,

Macro Economics Classical macroeconomics is the theory and the classical model of the economists Adam Smith, David Ricardo, John Mills and Jean Baptiste Say. Below the assumptions of the classical macroeconomics are described. 1. Assumptions: Competitive markets: Classical theories all make many assumptions about the markets and their competitiveness.these assumptions are that all the markets are easy to enter and exit. No monopoly elements are present in the market to prevent newcomers from entering the market or stopping the present ones from quiting the market. Pricess and wages are flexible in both upward and downward directions according to the demand and supply forces. No single seller or buyer of a product has sufficient market power to influence the industry price, nor does any supplier or purchaser of labor services have sufficient market power to influence the market wage rate. Thus all economic agents are price-takers and not price-setters. Because the markets are competitive, a disequilibrium can only exist for a short period of time which economists call the short run. The firm can not change some of its aspects of operation. So every firm has some fixed inputs while the pricess and the wages are changing and flexible. So, if for some reason the product market were experiencing excess demand in some industry, with quantity demanded greater than quantity supplied, prices would rise until quantity demanded once again equaled quantity supplied. The rise in price returns the market to equilibrium. On the factor side, if there were an excess supply of workers, wages would decline until equilibrium in the labor market was restored and everyone who wanted to work can find a jobwhich is called the full employment. Perfect information: In classical theory all economic decision-makers are assumed to be operating by having all the information they needed to make the best decisions. The cost of acquiring information, transactions costs are so low that they can be assumed to be negligible. So, consumers, producers and workers know the prices and wages existing among traders in the markets and aware of their options and new products which recently entered the market. No one would be privy to some special information providing them with an advantage for long. Full employment: As a result of the above assumptions, a prediction of the classical system is that is essentially operates at full employment on a long-run equilibrium path over time. While in the short run unemployment can result, it can't exist permanently because wage rates fall when there is excess supply of labor. As workers compete for jobs,then by the law of demand wage rates fall and the quantity of labor services hired by firms increases. Alternately, if there were a labor shortage, the wage rate would rise as firms compete for workers. The classical model incorporates the notion that the economy is on a long-run moving equilibrium path, and any deviations from long run equilibrium are nor permanent because wage and price flexibility can remove excess demands or excess supplies. Let us summarise the assumptions we made above: 2. SAY's Law : The equilibrium real wage defines full employment of the labor force, and full employment of the labor force ( with a given production function ) defines the full employment level of output. Classical theory found no obstacle to the attainment of these positions as long as the money wage was flexible - that is, as long as it would fall in the face of unemployment. The possibility that this level of output once produced wouldn't find a market was dismissed; Say's Law ruled out any deficiency of aggregate demand. Say's Law, simply states that " supply creates its own demand. " More precisely it states that whatever the level of output, the income created in the course of producing that output will necessarily lead to an equal amount of spending and thus an amount of spending sufficient to purchase the goods and services produced. Thus, if output is below that which can be produced with a fully employed labor force, inadequate demand can not stand in the way of an expansion of output. As long as there are idle resources that can be put to work, the very expansion of output resulting from the utilization of such resources will create a proportionate rise in income that will be used to purchase the expanded output. In this way, this law, denied that involuntary unemployment could be caused by a deficiency of aggregate demand. 3. Markets The equilibrium levels of output and employment are determined in the classical system as soon