# Classical general equilibrium model

Classical general equilibrium model

The classical general equilibrium model aims to describe the economy by aggregating the behavior of individuals and firms. Note that the classical general equilibrium model is unrelated to classical economics, and was instead developed within neoclassical economics beginning in the late 19th century.

In the model, the individual is assumed to be the basic unit of analysis and these individuals, both workers and employers, will make choices that reflect their unique tastes, objectives, and preferences. It is assumed that individuals' wants typically exceed their ability to satisfy them (hence scarcity of goods and time). It is further assumed that individuals will eventually experience diminishing marginal utility. Finally, wages and prices are assumed to be elastic (they move up and down freely). The classical model assumes that traditional supply and demand analysis is the best approach to understanding the labor market. The functions that follow are aggregate functions that can be thought of as the summation of all the individual participants in the market.

## Labor demand

The consumers of the labor market are firms. The demand for labor services is a derived demand, derived from the supply and demand for the firm's products in the goods market. It is assumed that a firm's objective is to maximize profit given the demand for its products, and given the production technology that is available to it.

Some notation:

Let p be price level of commodities
Let w be nominal wage
Let ω be real wage (w/p)
Let π be profit of firms
Let LD be labor demand
Let YS be the firms output of commodities that it will supply to the goods market.


### Output function

Let us specify this output (commodity supply) function as:

YS(LD)

It is an increasing concave function with respect to LD because of the Diminishing Marginal Product of Labor. Note that in this simplified model, labour is the only factor of production. If we were analysing the goods market, this simplification could cause problems, but because we are looking at the labor market, this simplification is worthwhile.

### Firms' profit function

Generally a firm's profit is calculated as:

profit = revenue - cost


In nominal terms the profit function is:

$p \cdot \pi = p \cdot Y^{S} - w \cdot L^{D}$


In real terms this becomes:

$\pi = Y^{S} - \frac{w}{p} \cdot L^{D} = Y^{S} - \omega \cdot L^{D}$


### Firms' optimal (profit maximizing) condition

In an attempt to achieve an optimal situation, firms can maximize profits with this Maximized profit function:

$\frac{dY^{S}(L^{D})}{dL^{D}} = \omega$


When functions are given, Labor Demand (LD) can be derived from this equation.

## Labour supply

The suppliers of the labor market are households. A household can be thought of as the summation of all the individuals within the household. Each household offers an amount of labour services to the market. The supply of labour can be thought of as the summation of the labour services offered by all the households. The amount of service that each household offers depends on the consumption requirements of the household, and the individuals relative preference for consumption verses free time.

Some notation:

Let U be total utility
Let YD be commodity demand (consumption)
Let LS be labor supply (hours worked)
Let D(LS) be disutility from working, an increasing convex function with respect to LS.


### Households' consumption constraint

Consumption constraint = profit income + wage income

$Y^{D} = \pi + \omega \cdot L^{S}$


### Households' utility function

total utility = utility from consumption - disutility from work
U = YDD(LS)
substitute consumption:
$U = \pi + \omega \cdot L^{S} - D(L^{S})$

### Households' optimal condition

Maximized utility function:
$\frac{dD(L^{S})}{dL^{S}} = \omega$
When functions are given, Labor Supply (LS) can be derived from this equation.

## Aggregate demand

Y = C + I + G whereby Y is output, C is consumption, I is investment and G is government spending

## Monetary market

MV=PY(Fisher's Equation of Exchange)

## Real market

Wikimedia Foundation. 2010.

### Look at other dictionaries:

• General equilibrium — theory is a branch of theoretical microeconomics. It seeks to explain the behavior of supply, demand and prices in a whole economy with several or many markets. It is often assumed that agents are price takers and in that setting two common… …   Wikipedia

• Applied general equilibrium — (AGE) models were pioneered by Herbert Scarf at Yale University in 1967, in two papers, and a follow up book with Terje Hansen in 1973, with the aim of empirically estimating the Arrow Debreu General equilibrium model with empirical data, to… …   Wikipedia

• Dynamic stochastic general equilibrium — modeling (abbreviated DSGE or sometimes SDGE or DGE) is a branch of applied general equilibrium theory that is influential in contemporary macroeconomics. The DSGE methodology attempts to explain aggregate economic phenomena, such as economic… …   Wikipedia

• Computable general equilibrium — (CGE) models are a class of economic models that use actual economic data to estimate how an economy might react to changes in policy, technology or other external factors. CGE models are also referred to as AGE (applied general equilibrium)… …   Wikipedia

• Classical economics — is widely regarded as the first modern school of economic thought. Its major developers include Adam Smith, Jean Baptiste Say, David Ricardo, Thomas Malthus and John Stuart Mill. Adam Smith s The Wealth of Nations in 1776 is usually considered to …   Wikipedia

• Classical — The word classical has several meanings. In general, these meanings refer to some past time, works of that era or later works influenced by that time. Classical things are often seen as ordered and part of high culture or a golden age, and… …   Wikipedia

• Model (macroeconomics) — A model in macroeconomics is a logical, mathematical, and/or computational framework designed to describe the operation of a national or regional economy, and especially the dynamics of aggregate quantities such as the total amount of goods and… …   Wikipedia

• Classical theory of growth and stagnation — Classical economics refers to work done by a group of economists in the eighteenth and nineteenth centuries. The theories developed mainly focused on the way market economies functioned. Classical Economics study mainly concentrates on the… …   Wikipedia

• Classical mechanics — This article is about the physics sub field. For the book written by Herbert Goldstein and others, see Classical Mechanics (book). Classical mechanics …   Wikipedia

• Economic model — A diagram of the IS/LM model In economics, a model is a theoretical construct that represents economic processes by a set of variables and a set of logical and/or quantitative relationships between them. The economic model is a simplified… …   Wikipedia