The Theory Of The Classical School

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The classical school is one of the economic thoughts; the key assumption of this school is that the market system is the most efficient system in the sense that the unencumbered market mechanism ensures the optimal allocation and utilisation of scarce resources. They also believed that “Supply creates its own demand.” (The early debate on policy atavism) In other words, in the process of producing output, businesses would also create enough income to ensure that all of the output will be sold. Another assumption is that the market system automatically restores economic equilibrium from any temporary shock, meaning government intervention is unnecessary. The second school of thought is the Keynesian school; the key assumptions of this…show more content…
This has in turn causes the wage rate to fall and employment to increase; as a result from q1 to q2. “Any unemployment in the economy would be purely voluntary unemployment”.(classical theories of economics)

As the classical economist accepted Say’s law, they assumed there was nothing to stop the economy from rising to full employment. Providing job seekers were prepared to work for a wage that was no more than their productivity, businesses who are profit seeking would want to hire everyone who wants a job, ensuring that this level of output also reflects the full potential output of the economy and “thus guarantees the full employment” (lecture 4) because “supply creates its own demand”

It is evident that classical economist had “complete faith in markets”.(classical theories of economics) In the short run any rise in aggregate demand will lead to an increase in output (q1 to q2) but it will also lead to prices increasing. This is will happen as firms suffer from diminishing returns and are required to increase the prices of their products to cover the high level of costs. The increase in aggregate demand may come about for many reasons such as increases in the money supply, the lowering of the taxation levels and finally the increasing of government expenditure.

On the other hand in the long run, the situation will differ as the economy will move towards full employment by its self, and so any
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