Question

Classical theory at its crux is the one belief that prices, wages and interest-rates are at equilibrium in the long run, all on their own. How come they’re all lumped together in this way?

Answer 1

It is so because there is no rigidity or stickinesss in the classical system. A change in one nominal variable is reflected in another variable. It beleives that changes in nominal variables like price, wages and interest rates cannot affect real variable like output and employment as a change in nominal variable will be reflected by the accomodating change in the other and any distortion will be brought back to its equlibrium level by market forces. For example, if prices were to increase, it would lead to incrase in wages and costs with increaseing supply which will eventually reduce the demand and the price and wage will fall to the equilibrium level. Similarily, an increase in interest rate will induce greater savigs requiring greater investment opportunities, as these savings meet the investment opportunities, the demand for savings will reduce and the interest rate will fall.

Classical economists consider a market in full employment where all the variables are flexible, and the invisible hand is responsible for demand and supply equilibrium.