Page 56 - DECO201_MACRO_ECONOMICS_ENGLISH

Unit 3: Theories of Income, Output and Employment: Classical Theory

(c) More women joining labour force Notes
(d) Fall in investment
7. The ....................... curve represents the production function of the variable input labour.
(a) Aggregate demand

(b) Aggregate supply
(c) VMP
L
(d) Total Product
8. Which of these equations is not true, considering there is full employment?

(a) S= AS - C
(b) I= AD - C
(c) AD = AS
(d) C -S = C + I

9. The price at which the funds are lent and borrowed is .......................
(a) Wage
(b) Monetary price
(c) Rate of interest

(d) Real income

3.3 Determination of the Overall Price Level

In the classical model the 'overall price level' (P) is determined by the forces of demand for
money and supply of money.
Demand for Money

Demand for money means holding of money by the people for carrying out transactions. The
people hold a proportion of nominal income as money. Nominal income equals the price level
(P) multiplied by real income (Y). The nominal income thus equals PY. It means that transactions
worth the nominal income PY are carried out by the amount of money M held by the people.
Since M is a proportion of PY it means that a unit of M is used again and again to carry out
transactions during the year. The average number of times a unit of money is used for carrying
out transactions is called 'velocity of circulation of money' (V).

!
Caution The relation between demand for money (M) and nominal income (PY) is
summarized by the following equation:
MV = PY
The equation is called the 'Quantity Equation of Exchange'. By rearranging the equation,
we get:
Y
M = ( f ) P ( Y Y in the model)
V f

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