The Model Economy

In our model we assume a closed economy with no economic activity on the part of the state. Technical change is not considered explicitly and technical conditions of production are taken as constant. There is just one type of commodity produced which can be used for consumption and investment purposes. It is assumed that there is a constant relation between the employed volume of labour (E) and real output (Y), i.e. there is no overhead labour. The productivity of labour is constant up to full capacity output and we get a constant labour-output ratio (l). The capital-potential output ratio (v) which relates the real capital stock (K) to potential real output (Yv) is also supposed to be constant. The capital stock is assumed not to depreciate. The rate of capacity utilization (u) is given by the relation between actual real output and potential real output determined by the capital stock. Full utilization of the capital stock is not necessarily associated with full employment of labour. If output is limited by supply, it is the capital stock, rather than the labour force, which is the limiting factor. In the long period, labour supply can be assumed to adjust passively to labour demand as soon as full employment is approached, through rising participation rates or immigration.5