The classical general equilibrium model aims to describe the economy by aggregating the behavior of individuals and firms.[1] 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.[2]
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.
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
w
\omega
\pi
LD
YS
Let us specify this output (commodity supply) function as:
YS(LD)
Generally a firm's profit is calculated as: profit = revenue - cost
In nominal terms the profit function is:
p ⋅ \pi=p ⋅ YS-w ⋅ LD
\pi=YS-
w | |
p |
⋅ LD=YS-\omega ⋅ LD
In an attempt to achieve an optimal situation, firms can maximize profits with this Maximized profit function:
dYS(LD) | |
dLD |
=\omega
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.
Consumption constraint = profit income + wage income
YD=\pi+\omega ⋅ LS
total utility = utility from consumption - disutility from work
U=YD-D(LS)
U=\pi+\omega ⋅ LS-D(LS)
Maximized utility function:
dD(LS) | |
dLS |
=\omega
Y = C + I + Gwhereby Y is output, C is consumption, I is investment and G is government spending
MV=PY(Fisher's Equation of Exchange)