Classical Model:
According to classical model the level of output and
employment are completely determined by the supply factors. They believed in
vertical aggregate supply curve means a fixed supply at the full employment
level in the economy.
Assumptions about the labour market:
1.
Labour demand as well as labour supply are the
function of Real wage.
2.
Perfect knowledge of the market to all the
participants
3.
Money wages are perfectly flexible and assures
equilibrium in the labour market.
These assumptions lead to believe that in case of any
increase in aggregate demand (AD)in the economy the equilibrium level of output
and employment will remain unchanged because of vertical aggregate supply curve. In case of any rise in AD only prices would
rise and money wage will rise proportionately with the price level. Thus, Real
Wage remains unchanged at the new equilibrium level.
In classical system the role of AD is to determine the
price level as AS is fixed at natural level of output. The classical theory of AD
is an implicit theory based on the quantity theory of money. The quantity
theory provides a direct and proportional relationship between the money supply
and the level of income, In quantity theory of money other variables remaining
constant if there is an excess supply of money there will be a corresponding
excess demand for commodities which will cause qn increase in the aggregate price
level. Thus, the classical model has a monetary theory of aggregate demand.
