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1. In the Classical Model individuals only hold cash in order to satisfy the transactions demand...

1. In the Classical Model individuals only hold cash in order to satisfy the transactions demand for money. Explain. What does this imply as far as the market for goods and services is concerned?

2. With fully flexible wages, prices and interest rates the economy always settles at the full employment level of GDP. Explain.

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Answer #1

In classical model money is used for transactional purpose only. In other words money is neutral. This means people will not keep money with them and thus there will be no glut in market for goods and services.

2 Yes it is true that classicals believed so. E G if Aggregate demand falls, prices will fall. Consequently wages will fall. Aggregate supply will shift upwards so that aggregate supply meets aggregate demand at full employment level. Similarly if saving is greater than investment, interest rate will fall to restore equilibrium of saving and investment.

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