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Classical Theory Of Income Output And Employment Determination Pdf

classical theory of income output and employment determination pdf

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Classical economists such as Adam Smith and Ricardo maintained that the growth of income and employment depends on the growth of the stock of fixed capital and inventories of wage goods. But, in the short ran, the stock of fixed capital and wage goods inventories are given and constant. According to them, even in the short run full-employment of labour force would tend to prevail as the economy would not experience any problem of deficiency of demand. On the basis of their theory they denied the possibility of the existence of involuntary unemployment in the economy. The short- run classical theory of income and employment can be explained through the following three stages:.

Classical Theory of Income, Output and Employment Determination

In the short run, output fluctuates with shifts in either aggregate supply or aggregate demand; in the long run, only aggregate supply affects output. In economics, output is the quantity of goods and services produced in a given time period.

The level of output is determined by both the aggregate supply and aggregate demand within an economy. National output is what makes a country rich, not large amounts of money. For this reason, understanding the fluctuations in economic output is critical for long term growth. There are a series of factors that influence fluctuations in economic output including increases in growth and inputs in factors of production.

Anything that causes labor, capital, or efficiency to go up or down results in fluctuations in economic output. Aggregate supply is the total amount of goods and services that firms are willing to sell at a given price in an economy. The aggregate demand is the total amounts of goods and services that will be purchased at all possible price levels. Aggregate supply and aggregate demand are graphed together to determine equilibrium. The equilibrium is the point where supply and demand meet to determine the output of a good or service.

Supply and demand may fluctuate for a number of reasons, and this in turn may affect the level of output. There are noticeable differences between short-run and long-run fluctuations in output. Over the short-run, an outward shift in the aggregate supply curve would result in increased output and lower prices. An outward shift in the aggregate demand curve would also increase output and raise prices. Short-run nominal fluctuations result in a change in the output level.

In the short-run an increase in money will increase production due to a shift in the aggregate supply. More goods are produced because the output is increased and more goods are bought because of the lower prices. The AD curve shifts to the right which increases output and price. In the long-run, the aggregate supply curve and aggregate demand curve are only affected by capital, labor, and technology.

Everything in the economy is assumed to be optimal. In the long-run an increase in money will do nothing for output, but it will increase prices. Classical theory, the first modern school of economic thought, reoriented economics from individual interests to national interests. Classical theory was the first modern school of economic thought.

It began in and ended around with the beginning of neoclassical economics. During the period in which classical theory emerged, society was undergoing many changes. The primary economic question involved how a society could be organized around a system in which every individual sought his own monetary gain.

It was not possible for a society to grow as a unit unless its members were committed to working together. Classical theory reoriented economics away from individual interests to national interests. Classical economics focuses on the growth in the wealth of nations and promotes policies that create national expansion. During this time period, theorists developed the theory of value or price which allowed for further analysis of markets and wealth.

It analyzed and explained the price of goods and services in addition to the exchange value. Adam Smith : Adam Smith was one of the individuals who helped establish classical economic theory. Keynesian economics states that in the short-run, economic output is substantially influenced by aggregate demand.

Keynesian economics states that in the short-run, especially during recessions, economic output is substantially influenced by aggregate demand the total spending in the economy. According to the Keynesian theory, aggregate demand does not necessarily equal the productive capacity of the economy. Keynesian theorists believe that aggregate demand is influenced by a series of factors and responds unexpectedly. The shift in aggregate demand impacts production, employment, and inflation in the economy.

At the time that Keynesian theory was developed, mainstream economic thought believed that the economy existed in a state of general equilibrium. The belief was that the economy naturally consumes whatever it produces because the act of producing creates enough income in the economy for that consumption to take place.

It is important to understand the stances of the various school of economic thought. Although the beliefs of each school vary, all of the schools of economic thought have contributed to economic theory is some way. The Keynesian School of economic thought emphasized the need for government intervention in order to stabilize and stimulate the economy during a recession or depression.

In contrast, the Chicago School of economic thought focused price theory, rational expectations, and free market policies with little government intervention. The Austrian School of economic thought focused on the belief that all economic phenomena are caused by the subjective choices of individuals.

Unlike other schools, the Austrian school focused on individual actions instead of society as a whole. Privacy Policy. Skip to main content. Aggregate Demand and Supply. Search for:. Introducing Aggregate Demand and Aggregate Supply. Explaining Fluctuations in Output In the short run, output fluctuates with shifts in either aggregate supply or aggregate demand; in the long run, only aggregate supply affects output. Learning Objectives Differentiate between short-run and long-run effects of nominal fluctuations.

Key Takeaways Key Points In the short run, output is determined by both the aggregate supply and aggregate demand within an economy. The equilibrium is the point where supply and demand meet.

According to Hume, in the short-run, and increase in the money supply will lead to an increase in production. According to Hume, in the long-run, an increase in the money supply will do nothing. Key Terms nominal : Without adjustment to remove the effects of inflation in contrast to real. Classical Theory Classical theory, the first modern school of economic thought, reoriented economics from individual interests to national interests. Learning Objectives Identify the assumptions fundamental to classical economics.

Key Takeaways Key Points When classical theory emerged, society was undergoing many changes. Classical economics focuses on the growth in the wealth of nations and promotes policies that create national economic expansion.

Classical theory assumptions include the beliefs that markets self-regulate, prices are flexible for goods and wages, supply creates its own demand, and there is equality between savings and investments.

Key Terms self-regulating : Describing something capable of controlling itself. Keynesian Theory Keynesian economics states that in the short-run, economic output is substantially influenced by aggregate demand.

Shifts in aggregate demand impact production, employment, and inflation in the economy. Unemployment is the result of structural inadequacies within the economic system. It is not a product of laziness as believed previously. During a recession the economy may not return naturally to full employment. The government must step in and utilize government spending to stimulate economic growth. A lack of investment in goods and services causes the economy to operate below its potential output and growth rate.

Overcoming an economic depression required economic stimulus, which could be achieved by cutting interest rates and increasing the level of government investment. Key Terms Keynesian Economics : A school of thought that is characterized by a belief in active government intervention in an economy and the use of monetary policy to promote growth and stability. Licenses and Attributions. CC licensed content, Shared previously.

Income and Employment Theory

The modern theory of income and employment, for which we may thank the genius of J. Keynes , is without question the most important advance in economic analysis in the twentieth century. Keynes taught us to understand the nature of depressions and radically changed our thinking about how to deal with them. In addition to its profound influence on economic policy, the modern theory of income and employment has paved the way for important developments in many areas of economic analysis. The purpose of the present essay is to provide a broad, simple outline of the theory.

Macroeconomics: Theory and Policy by Vanita Agarwal

Income and employment theory

Income and employment theory , a body of economic analysis concerned with the relative levels of output, employment, and prices in an economy.

The Classical Theory of Employment and Output (Explained With Diagram)

In the short run, output fluctuates with shifts in either aggregate supply or aggregate demand; in the long run, only aggregate supply affects output. In economics, output is the quantity of goods and services produced in a given time period. The level of output is determined by both the aggregate supply and aggregate demand within an economy. National output is what makes a country rich, not large amounts of money. For this reason, understanding the fluctuations in economic output is critical for long term growth. There are a series of factors that influence fluctuations in economic output including increases in growth and inputs in factors of production.

It is due to slower growth of capital stock in the country. The entire labour force cannot be absorbed in productive employment, because there are not enough instruments of production to employ them. Occupations relating to agriculture, sugar mills, rice mills, ice factories and tourism are seasonal. In a growing and dynamic economy, in which some industries are declining and others are rising and in which people are free to work wherever they wish, some volume of frictional unemployment is bound to exist.


The complete classical model of income and employment determination in an economy in Fig. The aggregate production function is: Y = f (K, L) (). Criticism.


Chapter 9. The IS/LM Model

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. Production function shows the relationship between input and output. Assume there are two inputs—Labour and capital. Due to the assumption of short-run, output will be a function of Labour N with capital constant K , that is, output can be increased only by increasing the variable factor N with fixed factor K constant. With the help of these two functions output and employment is determined. As capital is constant in the short-run, output will change only with change in the labour input.

Congressional Research Service 2 Figure 1. Thus, in Keynesian framework, this determination depends mainly on the level of aggregate demand because during short run aggregate supply is constant with respect to given price. Full employment level of output of goods and services is the largest output that the economy is capable of producing when all its resources are fully employed. Keynesian Theory of Income and Employment!

Principles and Theories of Micro Economics. Definition and Explanation of Economics. Theory of Consumer Behavior. Indifference Curve Analysis of Consumer's Equilibrium. Theory of Demand.

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    Classical Theory of Income, Output and Employment Determination · 1. Short-​Run · 2. Full Employment · 3. No State Interference · 4. Price Mechanism.

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