Question

Macroeconomics

Schools of Thought In Class Assignment 1. Assume the economy is currently in long and short run equilibrium. a. Suppose that the government in this economy goes to war. Holding everything else constant, what do you predict will happen to real GDP and the aggregate price level in the short run? What type of gap is created? Use the AS/AD model to illustrate. a. According to a Classical economist, how can the economy move back to its potential? Explain how this self-correction of the economy occurs? Illustrate on the graph. What is the ending real GDP and aggregate price level? b. According to a Keynesian economist, what might prevent the economy from self-correcting back to its potential? What actions might they recommend that would close the gap all the way? Illustrate on the graph. What is the ending real GDP and aggregate price level?

Answer 1

1- In my opinion during war situation economy of a country suffer following condition.

• Public debt and levels of taxation increased during most conflicts.
• Consumption as a percentage of GDP decreased during most conflicts.
• Investment as a percentage of GDP decreased during most conflicts.
• Inflation increased during or as a direct consequence of these conflicts
• When comparing the direct multiplier effects of military spending to other forms of government spending, it is not as productive in economic terms as spending in infrastructure, education, or even as tax cuts to increase household consumption.
• In sum, the higher levels of government spending associated with war tends to generate some positive economic benefits in the short-term, specifically through increases in economic growth occurring during conflict spending booms. However, negative unintended consequences occur either concurrently with the war or develop as residual effects afterwards thereby impeding the economy over the longer term.

2 - Classical economists asserted that full employment in a normal feature of a capitalist economy. Full employment is defined as an absense of involuntary unemployment . There is a built in arrangement in the economy that makes the economy function at full employment level. If there is unemployment , then it is a temporary phenomenon. It is called frictional unemployment as the economy will automatically restore its full employment position.

ASSUMPTION OF THIS THEORY

1- supy create its own demand   , there is defiency of aggregate demand. There is neither overproduction nor underproduction. Increase in output will generatr an equal increase in income and spending . It mean that income and product will alway be at full employment level .if unemployment exits it will be voluntary .

2 - Flexibility wage rate - mean that real wage can change freely and quickly .this assumption ensure full employment. If unemployment in an economy then wage rate will fall .this will rise the demand for labour by producer till all labour is absorbed and full employment achieved .

• Full employment equilibrium - price flexibility ensure that in every market aggregate supply equal to aggregate demand.

3-- According to keyness economist, which applies in short run state that

(a) - an economy can be in equilibrium at less than full employment level.it is a normal situation.

(b) - Demand creates its own supply.

(c)- the aggregate demand for good and services determines the level of output, income and employment l. This is because the level of aggregate supply is constant and given in short run.

(d) - Goverment intervention through monetary and fiscal measure can help in bringing about equilibrium between Aggregate demand and aggregate supply .

Assumption of the theory

(a) Rigid wages and prices - it mean that wages prices do not change freely, Goverment intervene through minimum wage law to fix wages when supply of labour more. It result in involuntary unemployment.

(b) Constant marginal product of labour - marginal product of labour is addition made to total product when one or more unit of labour is employed. It is assumed to be constant implyimg addition made to output is same by every increment of labour employed..​​​​​