Assumptions

  1. 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.
  2. Perfectly competitive market1
    • Everyone has symmetric information, which is full and free.
    • All agents are price takers
  3. All agents try to maximize their returns.
    • Households maximize their utility
    • Firms, their profits
  4. 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.
  5. No money illusion
    • inflation is taken into account
    • All variables are looked at in “Real” magnitude and not the nominal magnitude.
  6. Money is only used as a medium of exchange
    • We don’t consider investments and other usages of money (like precautionary etc)
  7. Savings and Investments are sensitive to ROI and not level of income2
    • then and

Footnotes

  1. Deals mainly with information

  2. Unrealistic, in the real world, savings and investments do depend on income