This can be stated to be the oldest theory that was propounded by the earliest founders of economics, David Ricardo, Adam Smith, John Stuart Mill. According to this, economy is in a position of self-regulating mode, where it is totally assumed that economy is at full employment level.
If the new classical theories are taken into consideration, it can be stated that for an economy that is at full employment and is running at a standard rate, there are certain triggers as business cycle fluctuations. This is primarily because; there are certain technological changes and introductions that happen within an economy. To aptly reply to these sudden intrusions, these business cycles act in accordance.
To best understand classical view of macroeconomic theory, it is important to understand the conditions of aggregate demand and supply which are a part of this economic situation.
Aggregate fluctuations in demand:
Though this classical mode does not make usage of AS-AD mode, yet, it can be noted that such fluctuations can be depicted via this mode. In a classical economy, the biggest source of disruption is intrusion of a technological advancement. With this technological advancement there comes a change in total productivity.
With better machinery, it can be seen that producers provide people with higher level of output and therefore with such highly productive capital providing goods in a short span of time, demand for such goods increases. Now, to ensure that the plants that provide these goods are in the best condition, demand by the producers also increases and total expenditure on the whole rises.
Hence, with technological advancement, it can be stated that rate of maintenance of capital rises and charges associated with buying of new capital rates decreases comparatively.
Response in regards to aggregate supply:
In this case, it can be seen that aggregate supply curve is placed in contact with minimal wage rate. When classical view is taken into consideration, it can be viewed as wage rate being placed at a level behind this supply curve.
But the point is monetary wage rate adjusts itself in such a manner that when taken into consideration both the potential and real GDP formats are equal and the economy starts functioning in a general manner.
However, after a certain point of time, there comes a fluctuation rate in potential GDP format, with the reasons being similar to fluctuation in aggregate demand. Technological change being the most important factor that has to be considered in this case, simply because courtesy to these technical issues, productivity rates and capital buying rates see an increase. Thus, on the whole, it can be found that when there is rapid technological change, there is an increase in potential and real GDP rates, while on the contrary if there is a lag in technological change, there is a decrease in both real and potential GDP rates.
So, it is important that people keep a track of these details to get proper data for this supply segment.
The classical policy:
This view clearly depicts those aspects in the economy that act as a backlog for the economy to increase at a higher pace. Higher taxes are one of the primary reasons that act as a backlog for the economy. When any producer after producing a specific amount of goods and services has to pay a certain amount of tax, his expected profits immediately decrease.
Now, to ensure that his profit level is maintained at a standard level and a certain amount is maintained for his consistent investment, it is imperative that a particular area id reduced. This affects the rate of incentive which is reduced and this brings forth a reduced income for workers.
So, if these disincentive effects on employment rates, investment and taxes are reduced comparatively, it can be seen that economy can expand at a certain level.
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