consider a country with an economic structure consistent with the assumptions of the classical model. Suppose that businesses in this nation suddenly anticipate higher future proftability from investments they undertake today. explain whether or how this could affect the folling.
a the current equilibrium interest rate
b. the current equilibrium real gdp
c. current equilibrium employement
d. current eqilibrium savings
e, future equilibrium real gdp
All would increase due to economic growth and the shiftward of all curves rightward. Price level will be ambiguous.
To understand the potential effects of businesses anticipating higher future profitability on different economic variables in a classical model, let's examine each one:
a) The current equilibrium interest rate:
In the classical model, the interest rate is determined by the supply and demand for loanable funds. When businesses anticipate higher profitability, it is likely that they will have an increased demand for investment funds. As a result, the demand for loanable funds will shift to the right, causing an increase in the interest rate. Therefore, businesses' anticipation of higher future profitability may lead to an increase in the current equilibrium interest rate.
b) The current equilibrium real GDP:
According to the classical model, the equilibrium level of real GDP is determined by the full employment level, which is determined in the long run by factors like the availability of labor and capital. Therefore, changes in business expectations about future profitability should not directly affect the current equilibrium real GDP in the classical model.
c) Current equilibrium employment:
In the classical model, the equilibrium level of employment is determined by the full employment level, which depends on factors like the labor force and technology. Changes in business expectations about future profitability would not directly impact the current equilibrium employment in the classical model, as it is determined by long-run factors unrelated to short-term changes in businesses' expectations. However, if businesses' anticipation of higher future profitability leads to an increase in investment, it may indirectly contribute to higher employment in the future.
d) Current equilibrium savings:
In the classical model, savings come from households' disposable income, which is determined by the level of GDP. If businesses anticipate higher future profitability and invest more, it may increase current GDP, leading to higher disposable income for households. With higher disposable income, households may choose to save more in the current period, resulting in an increase in current equilibrium savings.
e) Future equilibrium real GDP:
In the classical model, changes in business expectations about future profitability can impact future equilibrium real GDP. If businesses anticipate higher future profitability, they are likely to invest more in the present. Increased investment can lead to an increase in capital stock and productivity, which, in the long run, may raise the economy's production capacity and potential output. As a result, higher future equilibrium real GDP can be expected due to increased investment and capital accumulation.
In summary, in a classical model, businesses' anticipation of higher future profitability can impact the current equilibrium interest rate, current equilibrium savings, and potentially future equilibrium real GDP. However, it is important to note that changes in business expectations do not directly affect the current equilibrium real GDP or employment in the classical model, as they are determined by long-run factors.