Classical theory of income determination. Classical Theory of Income, Output and Employment Determination 2023-01-04

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The classical theory of income determination is a macroeconomic theory that explains how the overall level of income, or aggregate output, in an economy is determined. It is based on the idea that the economy is in a state of long-run equilibrium, in which all markets, including the labor market, are in balance.

According to the classical theory, the level of income in an economy is determined by the interplay of three main factors: the quantity of labor, the quantity of capital, and the level of technology. The quantity of labor refers to the number of people available to work, while the quantity of capital refers to the amount of physical capital, such as machines and equipment, available to be used in the production of goods and services. The level of technology refers to the state of technological advancement in the economy, which can affect the efficiency with which labor and capital are used to produce output.

The classical theory suggests that the level of income in an economy is determined by the intersection of the aggregate supply curve and the aggregate demand curve. The aggregate supply curve represents the relationship between the level of income and the quantity of output that firms are willing and able to produce at a given price level. The aggregate demand curve represents the relationship between the level of income and the quantity of output that households, firms, and the government are willing to purchase at a given price level.

According to the classical theory, in the long run, the economy will always be in equilibrium at the level of output where the aggregate supply curve and the aggregate demand curve intersect. At this point, the level of income will be determined by the quantity of labor, capital, and technology available in the economy. If the economy is experiencing a recession and the level of income is below the equilibrium level, firms will experience excess capacity and will be willing to produce more output at the current price level. This will lead to an increase in the aggregate supply curve and a rise in the level of income. On the other hand, if the economy is experiencing an expansion and the level of income is above the equilibrium level, firms will experience excess demand and will be able to charge higher prices for their goods and services. This will lead to a decrease in the aggregate supply curve and a fall in the level of income.

The classical theory of income determination has been influential in shaping economic policy and has had a lasting impact on macroeconomic thinking. However, it has also been criticized for its assumptions about the economy being in long-run equilibrium and for its lack of consideration of factors such as monetary policy and government intervention. Despite these criticisms, the classical theory remains an important foundation for understanding how the overall level of income in an economy is determined.

Keynesian Theory of Income Determination

classical theory of income determination

It shows a simplified version of the circular flow of income diagram. Assumptions: ADVERTISEMENTS: Keynes attacked the fundamental assumptions of the classical model: a The classical belief that full-employment equilibrium will be reached in the long run is not acceptable to Keynes, who wants to solve the short run problems. Hence, there is no assurance that a full-employment output will be purchased in the product market. In the classical model the equilibrium levels of income and employment were supposed to be determined largely in the labour market. It assumes the existence of full employment. Follow Classical theory of employment surbhi mathur.

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Classical Theory of Income and Employment

classical theory of income determination

Share; Like; Download akanksha91. Two market forces demand and supply determine the full employment and corresponding real wage and output in the real market. A fall in product prices would reduce resource prices—particularly wage rates—in the process. The usual hypothesis, the law of demand, is that the quantity demanded of x would increase at the lower price. At low level of Labour input before N 1 ADVERTISEMENTS: The Production function is a straight line which exhibits constant returns to scale. Demand for money — Outline yMeaning of demand for money yFactors affecting the demand for money yTransaction demand for money yPrecautionary demand for money yAsset demand for money yMoney demand as a function of nominal interest rate and income 3 1. The results of decrease in money supply can be similarly worked out.

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Classical Theory of Income, Output and Employment Determination

classical theory of income determination

The confidence that market makes it possible to sell everything that is produced is based upon Say's law. But he did not favour wage reduction as a proper method of increasing employment. In the classical theory, aggregate supply curve AS is a vertical straight line at full-employment level of output Y F. This is why it is downward sloping. As MP N represents addition to output when the Labour input is increased, MP N curve represents the slope of production function. It does not affect the real factors. Since money has been regarded only as a medium of exchange, change in money supply affects the absolute and not relative prices.

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Determination of Income and Employment: Complete Classical Model

classical theory of income determination

Any imbalance between S and I would be brought about by changes in the rate of interest r. His ideas have made greater impact on governments and their role in solving unemployment until recent times. After N, till N 2 As we add more labour, output increases but at a decreasing rate i. Investment depends upon the marginal efficiency of capital and the rate of interest. The term 'aggregate' is used to describe any quantity that is a grand total for the whole economy.

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Classical theory of Income and Employment blog.sigma-systems.com

classical theory of income determination

It is positively related to the real wages. The producers who were reluctant to employ all workers at the original wage rate will now find it profitable to employ extra workers at lower wage rate. If we wish to build up a The Keynesian and Classical Determination of the Exchange Rate By Emil-Maria Claassen Contents: I. NO INTERFERENCE BY THE GOVERNMENT. Follow Classical theory of employment surbhi mathur. The initial output of Q 0 is restored, but at a lower equilibrium price P 2, determined by the intersection of D 1D 1 and S 1S 1. The intersection of the product demand curve DD and the product supply curve SS determine the equilibrium price P 0 and equilibrium output Q 0.

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Classical theory of income determination pdf

classical theory of income determination

This is true for other producers and for the whole economy. As a result, price level rises from P 0 to P 1. PRODUCER WILL DEMAND LABOUR UP TO THAT POINT WHERE REAL WAGES OF LABOUR IS THE VALUE OF MARGINAL PHYSICAL PRODUCT OF LABOR. This will encourage investment and discourage saving, thus, making the two equal. The level of output produced and hence the level of employment depends on the level of total spending in the economy.

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income determination, theory of

classical theory of income determination

The problem is not one of involuntary idle­ness of resources including manpower. Saving — Investment Equality: In the classical model, rate of interest is the equilibrating force between saving and investment. Total output is OQ 0 when OL 0 units of labour are em­ployed. According to them the rate of interest the price paid for the use of money was determined by the de­mand for and the supply of capital. The supply of labour, thus, depends on nominal and not real wages.

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ECONOMICS,COMMERCE AND MANAGEMENT: CLASSICAL THEORY OF INCOME AND EMPLOYMENT DETERMINATION

classical theory of income determination

Keynes, who believed that a capitalist economy contains no self- regulating mechanism that assures full employment, assigned an important role to government in the stabilisation of the economy. Keynesian model has been developed as a reaction against the classical model. This is shown in part c, where the product market supply curve has shifted from S 1S 1 to the position S 2S 2. The determination of output and employment in the classical theory occurs in labour, goods and money markets in the economy. It shows at very low level of output as we employ more labour to the given capital, productivity of the last worker added does not fall. Thus wage rates have to decline significantly to permit businesses to produce profitably at the new lower prices. Determination of interest rate in the money market 3.

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Classical and Keynesian Models of Income Determination Compared

classical theory of income determination

THERE IS DIRECT RELATION BETWEEN SUPPLY OF LABOUR AND WAGES. Any unemployment which existed at the equilibrium wage rate OW 0 was attributable to frictions or restrictive practices in the economy or was voluntary in nature. Keynes gave three reasons for holding cash: transaction motive, precautionary motive and speculative motive. 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. Thus S-I equality through adjust­ment in interest rate is ruled out.

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