Summary of Classical Model

Markets

Labor market

$$\begin{array}{rlrl}Y& =Y(\overline{K},L)& \to & \text{Aggregate Production Function}\\ L^d& =f(W/P_{-})& \to & \text{Labour Demand}\\ L^s& =g(W/P_{+})& \to & \text{Labor Supply}\\ & & & \\ L^d& =L^S=L& & \end{array}$$

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Money market

$$\begin{array}{rl}M& =kPy\\ M^d& =k(Py)⟹{\text{Money}}^d=\text{Nominal Income}\\ \Delta M& =\overline{k}p\overline{Y}\end{array}$$

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Goods market

$$\begin{array}{rlr}s& =s(r_{+})& \to \text{Savings by HH}\\ S& =I& \text{Equilibrated}\\ i& =i(r_{-})& \to \text{Investments by Firms}\end{array}$$

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Var	Equilibrium	Market
${\left(\frac{W}{P}\right)}_0$	Real Wage equilibrium	Labor Market
$P_0$	Price equilibrium	Money Market
$r_0$	Rate of Interest equilibrium	Goods Market

Outcome / Inferences / Implications of Classical Model

1. Full employment
2. Crowding out phenomena $⟹$ Fiscal policy is ineffective.
3. Neutrality of money $⟹$ Monetary Policy is ineffective
4. Classical Dichotomydoubt
   • To solve real, we don’t need nominal
   • To solve nominal, we don’t need real
5. Aggregate supply curve is vertical
6. All the variables are analyzed from real magnitude
7. Economy as a whole is self-regulative
8. Labor supply curve is backward bending
9. Supply side economics - Ignores demand

Differences Classical Model and Keynesian Model

Classical Model	Keynesian Model
Full Employment	Full employment is rare
Equilibrium is attained	Dis-equilibrium
$AD=AS$	$AD>AS$
Supply driven	Demand driven
$Y=C$	$Y=S+C$

Due to great depression

• 1929 unemployment rates $35\%$
• 1933 unemployment rates $25\%$

This is why Keynesian Model came into picture. $S^S$ was high. Demand was low.

Savings is the reason for less demand.

• The Income Expenditure Model
• Equilibrium Level of Income

Equilibrium is like a pendulum (dynamic).