Page 66 - DECO201_MACRO_ECONOMICS_ENGLISH

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

3.6 Keywords Notes

Aggregate Demand: It is the total value of final goods and services that all sections of the
economy taken together are planning to buy at a given level of income during a period of time.

Aggregate Supply: It is the value of final goods and services planned to be produced in an
economy during a period.
Classical Dichotomy: It refers to an idea attributed to classical and pre-Keynesian economics
that real and nominal variables can be analyzed separately.
Full Employment: An economy is said to be in full employment when its entire labour force is
gainfully employed.
Loanable Funds Market: It is a hypothetical market that brings savers and borrowers together,
also bringing together the money available in commercial banks and lending institutions
available for firms and households to finance expenditures, either investments or consumption.
Nominal Wages: Wages stated in terms of money paid, not in terms of purchasing power.

Real Wages: Income of an individual, organization, or country, after taking into consideration
the effects of inflation on purchasing power.
Velocity of Circulation of Money: The average number of times a unit of money is used for
carrying out transactions.

3.7 Review Questions

1. Show interrelation between markets through the 'circular flow of income'.
2. Explain labour, product and capital market equilibrium in the classical model.

3. Show that when capital market is in equilibrium the product market is also in equilibrium.
4. Explain how the labour, product and capital markets are simultaneously in equilibrium in
the classical model.

5. Show how there is direct and proportional relation between price level and demand for
money.
6. Explain how change in supply of money brings change in the price level.

7. Trace the effects of introduction of new technology (which increases labour productivity)
on labour, product and capital markets in the classical model characterized by full
employment and perfect wage price flexibility.

8. Define 'neutrality of money'.
9. Draw a labelled diagram to show the circular flow of payments among the four sectors of
an economy.

10. Sustained migration leads to an increase in labour stock in a certain economy. Analyze its
impact on long run levels of output, employment and real wages. How does the capital
market ensure the equilibrium in the product in this case?

Answers: Self Assessment

1. Real 2. Nominal
3. Aggregate supply 4. Say's Law

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