ECONOMICS: Principles and Applications 3e HALL & LIEBERMAN © 2005 Thomson Business and Professional Publishing The Classical Long-Run Model

Figure 1 The Labor Market 100 million = Full Employment 10 H E J B A LDLD Excess Demand for Labor Excess Supply of Labor LSLS Number of Workers Real Hourly Wage $20 15

Figure 2 Output Determination In the Classical Model 100 million Aggregate Production Function 100 million Number of Workers Real Hourly Wage $15 LSLS LDLD In the labor market, the demand and supply curves intersect to determine employment of 100 million workers. The production function shows that those 100 million workers can produce $7 trillion of real GDP. $7 Trillion = Full Employment Output Output (Dollars) Number of Workers

Figure 3 The Circular Flow Households Firms Goods MarketsFactor Markets Goods and Services Demanded $ Total Consumption Spending $ Total Income Resources Supplied $ Total Revenue of Firms $ Total Factor Payments Goods and Services Supplied Resources Demanded

Table 1 Flows in the Economy of Classica, 2004

Figure 4 Leakages and Injections C ($4 Trillion) IPIP ($1 Trillion) G ($2 Trillion) S ($1.75 Trillion) T ($1.25 Trillion) Leakages Injections C ($4 Trillion) $7 Trillion Total Output $7 Trillion Total Income = I P ($1 Trillion) G ($2 Trillion) Total Spending

Figure 5 Household Supply of Loanable Funds 1.5 Trillions of Dollars per Year Interest Rate 5% 3% A Saving (S) or Supply of Funds 1.75 B As the interest rate rises, saving or the quantity of loanable funds supplied increases.

Figure 6 Business Demand for Loanable Funds 1.5 Trillions of Dollars per Year Interest Rate 5% 3% A Planned Investment (I P ) or Business Demand for Funds 1.0 B As the interest rate falls, business firms demand more loanable funds for investment projects.

Figure 7 The Demand for Funds Summing business demand for loanable funds at each interest rate and the govern- ment's demand for loanable funds... gives us the economy's total demand for loanable funds at each interest rate. Trillions of Dollars per Year Business Demand for Funds (I P ) Interest Rate 5% 3% A 1.0 B 1.5 Government Demand for Funds (G – T) A 0.75 B Trillions of Dollars per Year Total Demand for Funds [IP + (G – T)] A B Trillions of Dollars per Year

Figure 8 Loanable Funds Market Equilibrium 1.75 Trillions of Dollars Interest Rate 5% E Total Supply of Funds (S) Total Demand for Funds [I P + (G – T)]

Figure 9 How the Loanable Funds Market Ensures that Total Spending = Total Output $1.25 Trillion Loanable Funds Market $1.0 Trillion $0.75 Trillion $1.75 Trillion $7 Trillion C ($4 Trillion) I P ($1 Trillion) G ($2 Trillion) C ($4 Trillion) $7 Trillion Total OutputTotal IncomeTotal Spending = Leakages T ($1.25 Trillion) S ($1.75 Trillion) Injections G ($2 Trillion) I P ($1 Trillion)

Figure 10 Crowding Out with an Initial Budget Deficit D2D2 Total Supply of Funds (S) CC % B A 5% H C  I P Funds ($ Trillions) Interest Rate D1D1

Figure 11 Crowding Out with an Initial Budget Surplus 1.25 Funds ($ Trillions) 7% B 5% A C S2S2 S1S1 Business Demand for funds (I P ) CC IPIP H