This presentation explains the two tenants which are central to classical economics.

1. Quuen'sCollegeBusinessStudies2012
CLASSICAL
ECONOMICS
Prepared by Timothy Durant
c
TOPIC
2

2. Quuen'sCollegeBusinessStudies2012
Classical Economics
Adam Smith J. B Say
1776 to 1930

3. Quuen'sCollegeBusinessStudies2012
Tenants of Classical Economics
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
If disequilibrium 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
At IR1 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 the wage 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 equilibrium in 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.