Classical Theory Assumptions

• All markets, goods, resources, and financial, are competitive. Prices go up and go down in all markets to make sure no shortages or surpluses exist.

• Governments have balanced budgets: G=T. Therefore government does not borrow.

• Households spend all their income unless interest rates are high enough to get them to save.

• Firms borrow just enough to finance I. The financial markets make sure S = I.

• There are no significant trade or flows with R.O.W.