Question

EQUILIBRIUM OUTPUT AND EMPLOYMENT 1. Derive the aggregate supply curve in the classical case. (Draw on the critical assumptions of classical economists in your explanation). 2. Within the classical model, analyze the following changes to the output equilibrium, price, real wage and employment: (a) decrease in technology (b) influx of foreign workers (c) decrease in money supply. 3. What is the role of money supply in classical theory? If money supply declines, what are the effects on income and price?

Answer 1

Question 1

An aggregate supply curve shows the relationship between quantities supplied at different levels of prices over a particular time period in the economy.

The classical model of aggregate supply curve has the following assumptions-

1. The economy is at full employment.

1. Prices adjust freely and there are no restrictions on the upper or lower levels. They’re completely flexible.

The classical aggregate supply curve looks like –

full employment A Quati supplied

Classical AS curve is vertical at the full employment level and does not intend to change from that level. It says that the economy will operate on this level only, may it have different price levels. Thus, the equilibrium stands at full employment level of the economy. Prices may move up or down but the production will remain the same.

According to this model, the economy will remain stable or move back to stability automatically if there’s any downturn of the economy in future.