Macroeconomic theories refer to the scientific theories that seek to describe the phenomena related to the macro-economy. In this case, the fundamental phenomena described by the macroeconomic theories include inflation, unemployment rates as well as the level of aggregate production. These theories also provide the necessary policy recommendations that could be used to correct the microeconomic challenges and enhance the economy’s performance. Is should be noted that there are a number of macroeconomic theories including the New Classical economics, Keynesian economics, Classical economics, Monetarism, and aggregate market (AS-AD) analysis (Williamson, 2000). This research paper project will take a critical analysis on the Classical Economics theory and its application to business profitability.
Description the Classical Economics Theory and Its Current Application
The Classical Economics theory was developed by the so-called “father of modern economics” Adam Smith (Weintraub, 2002). This theory was developed based on the concept that flexible prices will ensure the existence of a market equilibrium necessary for maintaining full employment production. Therefore, the main implication of this theory is that the intervention of the government is not necessary in maintaining economic stability. According to Vitez (2014), economics refers to the qualitative and quantitative study of production, distribution and allocation of economic resources. With this regard, the classical economics theory takes a unique approach regarding the economic study of consumer behavior, monetary policy as well as government spending. This theory is actually founded on the laissez-faire economic market concept. In this case, laissez-faire is also regarded to be a free market which is characterized by no or little government intervention in the economy.
Moreover, the free market as stipulated by the classical economics theory facilitates the individuals to act in accordance to their self-interests concerning the economic decisions. Consequently, this facilitates the allocation of resources according to the businesses’ and individuals’ desires within the marketplace. According to Vitez (2014), the classical economics utilizes the value theory in determining the economic market’s prices. It focuses on establishing long-term solutions to the economic problems. Other aspects that can also play a critical role in developing the classical economics theory include the impact of government taxes and regulations and inflation. Moreover, this theory also takes into consideration how to distort or improve the current free market environment. The primary principle behind the classical economics is that the economy is self-regulating. This implies that the economy has the capability of achieving its natural level of real output or GDP. This is the GDP that could be obtained when the resources of the economy are fully employed. However, despite the fact that there are various circumstances in the marketplace that could make the economy exceed or fall below the real GDP’s natural level, there exists a self-adjusting mechanism that always brings it back to its natural level.
Description of a Unique Idea or Scenario Where the Classical Economics Theory Is Applied
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The classical economic theory is applied in various scenarios. One of them is the flexibility of interest rates, prices and wages. The classical economic theory is based on its major assumptions. The first assumption in this theory is that the prices are flexible. It means that they are not restricted by market control or government regulations, due to what markets are capable of rapidly and efficiently achieving equilibrium. Particularly, the market is capable of eliminating any surplus and shortage that exists and thus attaining the balance between the quantity supplied and the quantity demanded (Weintraub, 2002). This is particularly critical for the resource markets whereby equilibrium implying unemployment is never a problem and the market maintains full employment. On the other hand, the classical economics’ second assumption is based on Say’s law. In this case, it is assumed that the aggregate production of the services and goods in the economy creates enough income to purchase all the output (Weintraub, 2002). As a result, Say’s Law assumes that the aggregate supply and aggregate demand are just temporary and rare occurrences in the market. The classical economics’ last assumption is referred to as saving-investment equality. This implies that the household sector’s saving is exactly equal to the business sector’s investment expenditures on capital goods.
The description on How Unique Idea of Flexible Prices Can Help a Business or Firm Maximize Profits
The classical economic theory assumes flexible prices, wages and interest rates. According to the classical economists, these circumstances will make the interest rates fall and thus the investors will demand much more of the available savings. Therefore, any increase in the savings will result in the corresponding increase in the investment expenditures via a decrease in the interest rate. This will make the economy return to its real GDP’s natural level. This is beneficial to the firms or businesses in that it will facilitate them to maximize profitability without any shortage of surplus in production. This flexibility of the prices, wages and interest rates is the classical theory’s self-adjusting mechanism that always ensures the natural level of the real GDP (Wadley, 2011). The interest rate’s flexibility is always turning the money market in equilibrium and hence preventing the real gross domestic product (GDP) from falling below the natural level.
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In addition, the wage rate’s flexibility also ensures that the labor market is always kept in equilibrium. This is also beneficial to the firms in that they are assured of a constant supply of the workforce. In this case, it should be noted that there is no surplus or shortage of workers in the marketplace. However, when the supply of the workforce exceeds the demand of the firms for workers, the wages paid to such workforce will fall significantly in order to ensure that all the workforce is fully employed. By so doing, the firms will continue enjoying their profitability owing to the fact that an increase in the workforce has no effect on the overall wages paid to the workers. Thus, the classical economists contend that any unemployment within the labor market should be regarded as voluntary unemployment, in the sense that workers remain unemployed simply by refusing to accept lower wages.
The macroeconomic theories are indeed useful in describing macroeconomic phenomena in the marketplace. It has been established that the classical economic theory was developed based on the idea that flexible prices will facilitate the existence of market equilibrium and in turn, facilitate full employment. The theory was founded on a free market with no or minimal government intervention. According to the classical economic theory, there exists a self-regulating mechanism in the economy that brings it back to its natural level of gross domestic product (GDP) whenever there is a shortage or surplus. This ensures that there always exists a balance between the quantity supplied and the quantity demanded. The theory’s idea of flexible interest rates, prices and wages is important in facilitating the businesses or firms to maximize profits.