classical economics chapter 11. part i: the classical economic system the centerpiece of classical...
TRANSCRIPT
Classical Economics
Chapter 11
Part I: The Classical Economic System
• The centerpiece of classical economics is Say’s law– Say’s law states, “Supply creates its own
demand”– This means that somehow, what we
produce – supply – all gets sold
11-4Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Why Does Anybody Work?• People work because they want money to
buy things– People who produce things are paid. They
spend this money on what other people produce
– As long as everyone spends everything that he or she earns, the economy is OK
• But, the economy begins to have problems when people save part of their incomes
– People do save, and saving is crucial to economic growth
• Without saving, we could not have investment – the production of plant, equipment, and inventory
11-5Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
• Think of production as consisting of two products: consumer goods and invest-ment goods (for now, we’re ignoring government goods)
• The money spent on consumer goods is designated by the letter C
• The money spent on investment goods is designated by the letter I
Consumer Goods and Investment Goods
11-6Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
11-7
Consumer Goods and Investment Goods
If we think of GDP as total spending, then
GDP would be C + I
If we think of GDP as income received, then
GDP would be C + S
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
11-8
Consumer Goods and Investment Goods
If we think of GDP as total spending, then
GDP would be C + I
If we think of GDP as income received, then
GDP would be C + S
GDP = C + I
GDP = C + S
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
11-9
Consumer Goods and Investment Goods
GDP = C + I
GDP = C + S
And since things equal to the same thing are equal to each other, we have
C + I = C + S
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
11-10
Consumer Goods and Investment Goods
GDP = C + I
GDP = C + S
Things equal to the same thing are equal to each other
C + I = C + S Next, we can subtract the same thing from both sides
of the equation. In this case we subtract C
I = S
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Say’s Law Revisited
11-11
HouseholdsHouseholds
Firms
7.0The economy produces a supply of consumer goods and investment goods (Aggregate Supply = AS)
AS
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Say’s Law Revisited
11-12
HouseholdsHouseholds
Firms
7.0AS=
The people who produce these goods (Households) spend part of their incomes on consumer goods
C=6.5
They save the restS=0.5
Their savings are borrowed by investors who spend this money on investment goods
I=0.5
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Say’s Law Revisited
11-13
HouseholdsHouseholds
Firms
7.0AS= C=6.5
S=0.5
I=0.5
GDP = C + IGDP = 6.5 + 0.5GDP = 7.0
GDP = 7.0 = Aggregate Demand (AD)
I = S
We can see that Say’s law holds up, at least in accordance with classical analysis. Supply does create its own demand. Everything produced is sold. (AS = GDP=AD)
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Supply and Demand Revisited
11-14Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Quantity
10
9
8
7
6D
S
2 4 6 8 10 12 14
The curves cross at a price of $7.30 and a quantity of 6
Supply and Demand Revisited
11-15Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Quantity of loanable funds
20
15
10
5
0
Supply ofsavings
Demand forinvestment
funds
The Loanable Funds Market
The demand and supply curves cross at an interest rate of 15 percent
Supply and Demand Revisited
11-16Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
14
12
10
8
6
4
2
0
S
D
Quantity
Market for Hypothetical ProductIf the quantity supplied is greater than the quantity demanded at a certain price (in this case $8), the price will fall to the equilibrium level ($6), at which quantity demanded is equal to quantity supplied.
Supply and Demand Revisited
11-17Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Quantity of labor
20
18
16
14
12
10
8
6
4
2
0
Supplyoflabor
Demandfor labor
Hypothetical Labor Market
If the wage rate is set too high ($9 an hour),the quantity of labor supplied exceeds the quantity of labor demanded. The wage rate falls to the equilibrium level of $7; at that wage rate, the quantity of labor demanded equals the quantity supplied
The Classical Equilibrium: Aggregate Demand Equals Aggregate Supply
• On the micro level, when quantity demanded equals quantity supplied, we’re at equilibrium
• On the macro level, when aggregate demand equals aggregate supply, we’re at equilibrium
• The classical economist believed our economy was either at, or tending toward , full employment
• So at classical equilibrium – the GDP at which aggregate demand was equal to aggregate supply – we were at full employment
11-18Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.