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Compare the Classical and Keynesian models, making the reference to,a) The labour market, b) The AS curve, c) The AD curve, d) The relationship between real and monetary variables.

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Introduction

Compare the Classical and Keynesian models, making the reference to a) The labour market b) The AS curve c) The AD curve d) The relationship between real and monetary variables. 1st lecture until 08/10/03 Plan Classical a) The labour market b) The AS curve c) The AD curve d) The relationship between real and monetary variables. Keynesian a) The labour market b) The AS curve c) The AD curve d) The relationship between real and monetary variables. Introduction Classical economics uses the fallacy of composition to aggregate individual components. It believes that microeconomic foundations are necessary. However, in contrast, Keynesian economists believe the behaviour of the whole economy to be different from the behaviour of individual components acting individually. It believes the whole economy has its own identity and therefore requires n a new theory. Keynesians believe, that by itself the economy may not produce optimum outcome and therefore government intervention is needed. Classical Useful because * Background to Keynesian revolution * Basis for new-classical models Based upon * Say's law of markets (supply causes demand) ...read more.

Middle

0 at equilibrium point A. * In the aggregate, DN = DS * Equilibrium employment = N0 Model d) * Determines equilibrium aggregate output at O*. In the classical model, aggregate supply always determines real output, due to the vertical AS curve. * Output can change due to changes in o Real choices o Technological conditions The above diagrams show Classical Derivation of AS from a perfectly flexible labour market. If price increases, wage increases in the competitive market to keep w/p constant. Therefore the AS curve is vertical. Conversely, if price level falls, the wage falls. Output is invariant (perfectly inelastic) with respect to price level, as with an equilibrium level of real wage (w/p), any change in price level is offset by a change in wages to maintain w/p. Aggregate Demand-Monetary side Sm is fixed exogenously (externally) by monetary authority Sm and Dm-----the quantity theory-----2 versions: Fisher: M V = P T VELOCITY DETERMINED - CLASSICAL M=money stock V=Velocity of circulation P=average level of P T=output of goods and services Cambridge: Md = kPY DEMAND DETERMINED - KEYNESIAN k=proportion of nominal income KEYNESIAN Labour market Unlike classical, ...read more.

Conclusion

Keynes spoke of the point of effective demand (POED) where AD=AS. Given this, we can say that Keynesian AD is a point on the Keynesian AS curve, and is determined by (in a closed, laissez faire market): Y = C + I where C = f(Y) I = f (r, mec) mec = marginal efficiency of capital, determined by supply price and perspective yield r = interest rate, determined by LP (liquidity preference) and M (demand for money). With a given p and expectations (taking mec out of the equation), Keynes AD is determined by r and Y, and is expressed in equilibrium terms (goods market and monetary market) in the IS-LM. Conclusion In the Classical model, due to the vertical AS curve, supply alone determines real output. In the Keynesian model, both supply and demand factors affect real output. In the Classical model, the position of the AD curve is determined by purely monetary variables (the role of demand was to determine p), whereas in the Keynesian model, both monetary and real variables determine its position. ...read more.

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