Question

Explain very briefly if the following statements are true or false. Mathematical or graphic treatment will be appreciated wherever possible or necessary.

7. In the classical model, aggregate supply conditions uniquely fix the level of output and employment which imply that both monetary policy and fiscal policy changes in money supply and government expenditures respectively do not have real effects.

8. A rise in the propensity to consume, implying an increase in the multiplier, rotates the IS curve anti-clockwise and makes it flatter.

9. A fall in the interest-sensitivity of investment function rotates the IS curve anti-clockwise and make it flatter.

10. A rise in the interest sensitivity of the demand for money has no effect on the intercept of the LM curve with the y-axis; it shifts the intercept with the vertical axis upward, rotating it clockwise direction about the horizontal intercept and making it flatter.

11. Given nominal money supply, a rise in the price level shifts the LM curve leftward with no change in the slope.

12. Aggregate demand in the classical model is determined by consumption demand, investment demand and excess of real money balances over the full employment level of output. This may be represented by the following equation: .

Answer 1

7 True

The Classical economists disagreed with the Mercantilist view who emphasized State interference and money factors, for the determination of real variables like output and employment.

According to Adam Smith, “it is the real factor which is more important.” Money was used only as medium of exchange.

Assumptions:

Short-Run

2. Full Employment

3. No State Interference

4. Price Mechanism

5. State of Technology and Population is constant

The Classical model of employment consists of 2 components:

I. Aggregate Production Function:

Production function shows the relationship between input and output. Assume there are two inputs—Labour and capital. Due to the assumption of short-run, output will be a function of Labour (N) with capital constant (K), that is, output can be increased only by increasing the variable factor (N) with fixed factor (K) constant.

Y = F(K, N) …(2.1)

Where K → Constant capital stock

N → Quantity of homogeneous Labour Input

Y → Real Output.

II. Labour supply and demand function:

With the help of these two functions output and employment is determined. As capital is constant in the short-run, output will change only with change in the labour input.