Macro Economics

Classical macroeconomics is the theory and the classical model of the economists

Adam Smith, David Ricardo, John Mills and Jean Baptiste Say. Below the
assumptions of the classical macroeconomics are described. 1. Assumptions:
 Competitive markets: Classical theories all make many assumptions about
the markets and their competitiveness.these assumptions are that all the markets
are easy to enter and exit. No monopoly elements are present in the market to
prevent newcomers from entering the market or stopping the present ones from
quiting the market. Pricess and wages are flexible in both upward and downward
directions according to the demand and supply forces. No single seller or buyer
of a product has sufficient market power to influence the industry price, nor
does any supplier or purchaser of labor services have sufficient market power to
influence the market wage rate. Thus all economic agents are price-takers and
not price-setters. Because the markets are competitive, a disequilibrium can
only exist for a short period of time which economists call the short run. The
firm can not change some of its aspects of operation. So every firm has some
fixed inputs while the pricess and the wages are changing and flexible. So, if
for some reason the product market were experiencing excess demand in some
industry, with quantity demanded greater than quantity supplied, prices would
rise until quantity demanded once again equaled quantity supplied. The rise in
price returns the market to equilibrium. On the factor side, if there were an
excess supply of workers, wages would decline until equilibrium in the labor
market was restored and everyone who wanted to work can find a jobwhich is
called the full employment.  Perfect information: In classical theory
all economic decision-makers are assumed to be operating by having all the
information they needed to make the best decisions. The cost of acquiring
information, transactions costs are so low that they can be assumed to be
negligible. So, consumers, producers and workers know the prices and wages
existing among traders in the markets and aware of their options and new
products which recently entered the market. No one would be privy to some
special information providing them with an advantage for long.  Full
employment: As a result of the above assumptions, a prediction of the classical
system is that is essentially operates at full employment on a long-run
equilibrium path over time. While in the short run unemployment can result, it
can’t exist permanently because wage rates fall when there is excess supply of
labor. As workers compete for jobs,then by the law of demand wage rates fall and
the quantity of labor services hired by firms increases. Alternately, if there
were a labor shortage, the wage rate would rise as firms compete for workers.

The classical model incorporates the notion that the economy is on a long-run
moving equilibrium path, and any deviations from long run equilibrium are nor
permanent because wage and price flexibility can remove excess demands or excess
supplies. Let us summarise the assumptions we made above: 2. SAY’s Law : The
equilibrium real wage defines full employment of the labor force, and full
employment of the labor force ( with a given production function ) defines the
full employment level of output. Classical theory found no obstacle to the
attainment of these positions as long as the money wage was flexible - that is,
as long as it would fall in the face of unemployment. The possibility that this
level of output once produced wouldn\'t find a market was dismissed; Say\'s Law
ruled out any deficiency of aggregate demand. Say\'s Law, simply states that
" supply creates its own demand. " More precisely it states that
whatever the level of output, the income created in the course of producing that
output will necessarily lead to an equal amount of spending and thus an amount
of spending sufficient to purchase the goods and services produced. Thus, if
output is below that which can be produced with a fully employed labor force,
inadequate demand can not stand in the way of an expansion of output. As long as
there are idle resources that can be put to work, the very expansion of output
resulting from the utilization of such resources will create a proportionate
rise in income that will be used to purchase the expanded output. In this way,
this law, denied that involuntary unemployment could be caused by a deficiency
of aggregate demand. 3. Markets The equilibrium levels of output and employment
are determined in the classical system as soon as we are given (a) the economy\'s
production function, from which is derived