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Long runa.Optimistic modelb.The price in any market adjusts until quantity supplied and quantity demands is equal1)Law of supply and demand2)Markets cleari.Critical assumptionc.The Classical modelA.Starts in labor market1.(W/P)i.Wage over price levelii.Workers care about their real wage (purchasing power of their wage)a.Upward curvingi.Labor supply curveb.Labor supply2.By firms who care about real wagea.Downward slopingi.Labor demand curveb.Labor Demand3.Intersection of demand and supply curvea.Unemployment happens if real wage is too highb.# of people who should be workingi.Equilibrium is also Lfe (full employment)c.Equilibrium 4.Classical equilibriumB.Unemployment caused by real wage too high1.In free market, the wage would come down2.Min wagea.Labor Unionb.Therefore government fault3.Explanation for UnemploymentC.L = # of workersa.K = capital stockb.R = land and natural resourcesc.E = entrepreneurialship d.Y = output/Real GDPe.Variables1.Variables can be combined for output2.E, R, K = Fixed for the year3.L = determines economy for the year4.Diminishing return to labor1)Upward but lower slope each timei.Upward curvea.L and Yb.Aggregate Production functionc.Model5.Drag down to lower grapha)Gives the full level of employment (Lfe)1)W/P and Li.Two graphsa.To explain6.Classical view of outputD.*Classical model10/2/12 -ch 8 The Classical ModelTuesday, October 02, 201211:10 AM Lecture Notes Page 1Drag down to lower grapha)Full output that the economy should be producinga)Potential outputb)Y will then be Yfe1)Y and Lii.iii.In Classical Model, everyone always willi.But just because output should be that much, what if no one wants to buyb.Total Output will by factor payments create equal amount of total income, then everyone spends income so spending Is equal amount1.2.Businesses by producing output, also create a demand for goods and services3.Total spending will equal total outputa.Supply creates its own demandb.Say's Law4.Spending in a very simple EconomyE.Assume closed economy1.Spending in more realistic EconomyF. Lecture Notes Page 2Assume closed economy1.Government collects taxes and purchases goods and services2.Spending decision makers only want to doi.Exclude unintended inventory changes, in our model exclude allii.iii.Planned Investment Spending (I^p)a.T = tax revenue - transfer paymentsi.Net Tax Revenue (T)b.Total income - net taxes (T)i.Disposable Incomec.Disposable income - C (consumption spending)i.Household Saving (S)d.Total Spending = C + I^p + Gi.Total Spending in more realistice.New Variables3.Again say's law holds. Total Spending = total output4.Savings and Net Taxes (T) are leakagesi.Households don't spend all incomea.Government spending (G)i.Planned Investment Spending (I^p)ii.Government and businesses spend backb.Total Spending equals total output if leakages = injectionsc.d.Leakages and Injections5.Household sectors can supply funds1.Business firms and Gov. Demand funds2.Equal to household savinga.As Interest rate rises, more people want to save to lendi.Curves upwardii.Supply of Funds Curveb.The Supply of Loanable Funds3.Demand curve slopes downi.Borrow more when lowii.Business demand I^pa.Government always demands this amounti.Vertical Demand Curveii.Governments run a budget deficit equal to G-Tb.Total Demand for Funds Curvec.The Demand for Loanable Funds4.The Loanable Funds MarketG. Lecture Notes Page 3I^p + (G-T)i.Total Demand for Funds Curvec.Market clearsa.Equilibrium5.Now we know that Leakages always equals Injections1.Savings all go towards Government Spending or planned investment spending2.As long as loanable funds market clears, say's law holds3.Total value of spending will equal total value of output4.Loanable Funds Market and Say's LawH.When government changes either net taxes or its own purchases in order to influence total output1.Arise from fiscal policy's impact on total spendinga.Shift the demand curve through government purchases, transfers, net taxesb.In Classical Model - fiscal policy has no demand-side effectsc.Demand-Side Effects2.To spend more, government needs more money without raising taxesa.If saving is more, consumption spending is lessi.Borrows from loanable funds market, drives up interest rate, business spend less and more people want to save moreb.Increase in government purchases crowded out the spending of households and businessesc.In classical model, a rise in government purchases causes complete crowding outd.e.Increase in Government Purchases3.a.Consumption falls by the amount more savings goes up.1)Later since demand exceeds supply, interest rate rises and more people want to savei.Raises consumption by amount of taxes cut at first since people have more disposable income initiallyb.Decrease in Net taxes4.Fiscal Policy in the Classical ModelI. Lecture Notes Page 4Find net change in C by AH - AFa)Consumption falls by the amount more savings goes up.1)Investments falls, since higher interest rate2)Decrease in net taxes raises C which completely crowds out I^pc.Total spending remains unchanged so tax cut has no demand-side effectsd.Short runa.Explains how economy runs on short runb.Keynesian modelJ. Lecture Notes Page 5Real gross domestic product per capitaa.Real GDP / Populationb.Measuring standard of livingA.If variable growing by x each year, it will double in 70/x yearsa.Rule of 70B.Output per houri.Total output/total hours workedii.Productivitya.Total hours/total employmenti.Average hoursb.Total employment/populationi.Employment-population Ratio (EPR)c.i.Combinedd.Determinants of Real GDPC.Ch 9Wednesday, December 19, 201212:07 PM Lecture Notes Page 6Changes in GDP (Living standards)Total Output = Total OutputA.Productivity (output per hour)i.Total output / total houra.Average hours workedi.Total hours / total employmentb.EPRi.Total employment / populationc.Populationd.Total output = (Total output / total hour) * (total hours/total employment) *(total employment / Population) *populationB.%delta (A+B) = %delta A + %delta Ba.%Delta Total output = % delta (productivity + Average hours + EPR + Population)i.Appliedb.Rule #4 C.Total output = productivity x average hours x EPR x populationa.Apply rule #4 to this^1)Total output per capita = productivity x average hours x EPR i.Usually only EPR and productivity determine GDPii.Total output / population = total output per capitab.Total Output per CapitaD.Greater total employment increases EPR ->rise in real GDPa.Increase in labor supply lowers wage rate, but since more people

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NYU ECON-UA 1 - The Classical Model

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