Assignment

ECO161: Fundamentals of
Macro Economics
Homework-III

Q1: Compare the classical and Keynesian views on the speed of wage
and price adjustment. What are the important consequences of the
differences in their wages?
Ans:
Keynesian explained rigid wages and prices to provide an explanation of
non-market clearing. In particular they have used wage rigidity to explain
unemployment.
If the going wage exceeds the equilibrium wage, we argue that the wage will
fall. Because the quantity of workers supplied exceeds the quantity
demanded. This will bid the price of labor, the wage, down. The wage falls
till the market clears.

Classical explained there is full employment but may be chances of

voluntary unemployment. People don’t want to work until there is work in the
economy. Classical economists have a more sophisticated version of their
model to account for unemployment. Workers and jobs have different
requirements, so there is a matching problem. It takes time to match workers
to jobs, so there is always some unemployment. Unemployment rises in
recessions because productivity shocks cause increased mismatches
between workers and jobs.

Q2: Why does the aggregate demand curve slope downwards? Give
real world examples of three effects that explain the slope of the
curve?

Ans:
• Aggregate demand curve slope always downwards, it is due to the
relationship between price and demand. As aggregate level of price of
increases and level of demand decreases then it results to downward
slope.

• As the price level falls the interest rate also tends to fall.
the price level drops, interest rates fall, domestic investment in foreign
countries increases, the real exchange rate depreciates, net exports
increases, and aggregate demand increases.

Q3: Suppose the economy is currently in a recession. If policy makers

take no action, how will the economy change overtime? Explain in
words and using an aggregate demand and aggregate supply diagram.

Ans:
According to classical theory concept there is full employment and the
chances of voluntary unemployment i.e. there is work in the economy but
people don’t want to work. According to this concept there it is explained that
there is no unemployment and no recession that stay in the economy for
longer. It says that if there is recession in the economy, it will going to be
reduced automatically.

Q4: According to Keynes full employment is not a normal feature of the

economy. What are the various factors suggested by Keynes which are
helpful in increasing the level of employment in India.

Ans:
According to Keynes concept there may be full employment, over
employment and may be under employment. According to Keynes concept if
there is increase in the level of Aggregate demand then there will decrease
in the unemployment level which means employment will increase. To
increase the in the aggregate demand we have to increase the 2 factors i.e.
Consumption and Investment. If these two factors will increase then this will
automatically effects on the employment level of India.

Q5: In 2002, President George W.Bush imposed tariffs on certain types

of imported steel.
He argued that foreign steel producers were dumping their steel on the
U.S. market at low prices. The foreign steel producers were able to sell
steel cheaply because they received subsidies from their governments.
The bush administration argued that the influx of steel was disrupting
the U.S. economy, harming the domestic steel industry, and causing
unemployment among U.S. steel workers. What might a classical
economist say in response to these claims? Would a Keynesian
economist be more or less sympathetic to the imposition of tariffs?
Why?

Ans: According to classical concept there is no interference of Govt. in the

market as it is free market situation there is no possibility of general
unemployment or instability in the normal situation.
In classical concept there is flexibility of wages, interest and prices. This help
in bringing full employment itself.

According to Keynes concept there is no chances of free market as there is

govt. interference in the economy. Every policy is there made by
government. Full involvement of government is there in Keynes concept.
Acc. To Keynes employment can be increase only when there is increase in
the level of aggregate demand.
And to increase in the level of aggregate demand there are other 2
determinants that must be increased like consumption and investment factor.
Keynesian model is more valuable than Classical concept as it involves all
the policies and other factors by the govt. and the imposition of tariffs.