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Classical economics Introduction
This document discusses some of the key tenants of classical economics from Adam Smith and J.B. Say from 1776 to 1930. It outlines Say's law that supply creates its own demand, and that wages, interest rates, and prices are flexible. This flexibility means that any disequilibriums in markets will be temporary and equilibrium will be restored. It provides examples of how flexible interest rates and flexible wages allow disequilibriums to be cleared through adjustments over time. The document also notes that classical economics considers some unemployment to be voluntary as individuals may choose not to work at the equilibrium wage rate.
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Classical economics Introduction
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- 2. Quuen'sCollegeBusinessStudies2012 Classical Economics Adam SmithJ. B Say 1776 to 1930
- 3. Quuen'sCollegeBusinessStudies2012 Tenants of ClassicalEconomics Say’s Law Flexibility Supply creates its own demand. If firms expand production, they will have t hire workers. More workers employed means increased incomes and increased incomes results in greater demand. Wages, interest rates and prices are all flexible. Therefore any disequilibrium in resource markets in time will be cleared.
- 4. Quuen'sCollegeBusinessStudies2012 Flexible Interest Rates Ifdisequilibrium exist and savings equal $100m while the level of investment equals $90m. This would mean that the supply of loanable funds (savings) exceeds its demand. If banks have excess of liquidity in the system, the automatic response is to lower the interest rate, encouraging firms to borrow and discouraging savings. Equilibrium is therefore restored because of the assumption of flexible interest rates. Any disequilibrium is short lived.
- 5. Quuen'sCollegeBusinessStudies2012 Flexible Interest Rates AtIR1 the supply of loanable funds is 100m, however, demand is 90m. In the long run, banks will lower interest and equilibrium will be restored at IR.
- 6. Quuen'sCollegeBusinessStudies2012 Flexible Wages If thewage rate (W1) is above the equilibrium wage rate (W). This in the short run will create a surplus of QD1QS1. However the assumption that wages are flexible implies that in the long run, the wage rate will fall and correct the disequilibrium.
- 7. Quuen'sCollegeBusinessStudies2012 Voluntary Unemployment At equilibriumin the labour market, a type of unemployment exist. Given that some individuals choose not to work at the equilibrium wage rate, they are considered to be voluntarily unemployed.