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In: Economics

In the classical model, contractionary and expansionary monetary policy will change N (labor) and Y (Real...

In the classical model, contractionary and expansionary monetary policy will change N (labor) and Y (Real GDP), but not P (price level) and W (wage). Do you agree or disagree with this statement?

Explain and diagrammatically represent your answer.

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Expert Solution

I disagree with this statement.

In the classical model, Aggregate Supply Curve is Vertical. As a result of which, any policy to influence Aggregate Demand, be it Contractionary or Expansionary will not affect the N and Real GDP. The only effect would be on the Price level. This is because there is perfect information regarding the price level in the Economy and full flexibility of money wage in the classical model. This leads to a situation of full employment in the Economy always and thus, to a Vertical Aggregate Supply Curve. This can be seen in the diagram below. A policy to Change Aggregate Demand doesn't have any effect on Employment and Real GDP. These Policy only changes the price level in the Economy. In the labour market also, there is no change in Employment because the wages adjust themselves to maintain full Employment in the labour market.

Rahul Sunny answered 2 years ago
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