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Describe the role of money in the economy according to the Classical model.

Describe the role of money in the economy according to the Classical model.

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Answer #1

In classical model, money is considered as neutral. It is considered as a medium of exchange in this model and it does not determine the income, employment in the economy.

Also money in classical model determines the general price level and also is represented in the quantity theory of money.

The equation of quantity theory of money is given by

MV=PT

Where M = supply of Money

V= velocity of money

P= general price level

T= transactions in economy

Thus in classical economy, the real variables are controlled by real factors and only nominal factors are affected by monetary factors. This is classical dichotomy and thus money is considered neutral.

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