Assumptions
- Short run, static and closed economy model
- short run: Doesn’t refer to time-frame, in the usual sense. In the short run the goal of the policy need not be realized. The end result is not seen.
- static: Standalone, the impact of the policy is not realized in other sectors.
- closed: there is a restriction to imports and exports and the external effect is reduced.
- Perfectly competitive market1
- Everyone has symmetric information, which is full and free.
- All agents are price takers
- All agents try to maximize their returns.
- Households maximize their utility
- Firms, their profits
- Perfect Wage, Price and ROI Flexibility
- the markets are in equilibrium all the time
- when demand and supply mismatch, the equilibrium shifts due to the adjustments in these parameters due to which they are called perfectly flexible.
- No money illusion
- inflation is taken into account
- All variables are looked at in “Real” magnitude and not the nominal magnitude.
- Money is only used as a medium of exchange
- We don’t consider investments and other usages of money (like precautionary etc)
- Savings and Investments are sensitive to ROI and not level of income2