Question

3. What form of unemployment is consistent with the Classical Model?

4. Provide a brief explanation of the Quantity Theory of Money.

5. Why is monetary policy ineffective to combat recession in the world of the Classical Model?

Answer 1

Ans-3 The classical theory assumes over the long period the existence of full employment without inflation.

Given wage-price flexibility, there are automatic competitive forces in the economic system that tend to maintain full employment and make the economy produce output at that level in the long run.

Thus, full employment is regarded as a normal situation and any deviation from this level is something abnormal since competition automatically pushes the economy toward full employment.

Ans-4 Quantity Theory of Money:

The quantity theory of money is a theory about the demand for money in an economy. The most common version, sometimes called the "neo-quantity theory" or Fisherian theory, suggests there a mechanical and fixed proportional relationship between changes in the money supply and the general price level. This popular, albeit controversial, formulation of the quantity theory of money is based upon an American economist Irving Fisher .

Ans-5 In the world of classical model, monetary policy is very ineffective. Some of the shortcomings come from the asymmetry of the policy, changes in velocity (which may frustrate policies), the uncertainty of investment to be undertaken (especially if not interest sensitive). In addition, a feedback exists in interest rates because interest rates are also costs and affect inflation which decreases wealth and, therefore, consumption.

In most of the countries, it is generally accepted that monetary policy is adequate for controlling inflation , but is inadequate for economic stimulation. Fiscal policy is considered the appropriate tool for controlling economic activities.