In the classical school of Economics, prices are important in achieving markets equilibrium. a. Explain how prices are supposed to ensure market equilibrium. (10 pts) b. In reference to the closed economy model in chapter 3, identify each one of the main three markets and specify the price that meant to ensure market equilibrium. Briefly state how each price leads to equilibrium. (15 pts) c. Which price you mentioned in part (b) has special role

a. In classical economics, prices play a crucial role in achieving market equilibrium through the mechanism known as "supply and demand." Market equilibrium occurs when the quantity of goods supplied by producers equals the quantity of goods demanded by consumers. When there is excess supply, prices tend to fall to encourage more consumers to buy and producers to produce less, which reduces the surplus. Conversely, when there is excess demand, prices tend to rise, prompting producers to produce more and consumers to purchase less, which reduces the shortage. The equilibrium price is the price at which the quantity supplied equals the quantity demanded.

b. In the closed economy model, there are typically three main markets: the goods and services market, the labor market, and the financial market.

* Goods and Services Market: The equilibrium price in this market is the price level of goods and services exchanged. The price leads to equilibrium by adjusting in response to the levels of aggregate demand and supply. When the price level is such that consumers and businesses demand the exact amount of goods and services that firms are willing to produce, the market is in equilibrium.

* Labor Market: The price in the labor market is the wage rate. Equilibrium in the labor market is achieved when the wage rates adjust so that the number of workers firms are willing to hire equals the number of workers willing to work. This reflects a balance between supply (workers seeking employment) and demand (employers seeking workers).

* Financial Market: The equilibrium price in the financial market is the interest rate. The interest rate balances the amount of savings supplied by households and the demand for investment by firms. When the interest rate is at a level where the amount of savings equals investment, the financial market is in equilibrium.

c. The price in the labor market, which is the wage rate, has a special role because it directly affects individuals’ incomes, their consumption choices and therefore the overall level of economic activity. It is also a significant cost for firms and thus influences the prices of goods and services. Moreover, the wage rate can affect aggregate demand through its influence on consumers' disposable income.

The concept of market equilibrium is foundational to classical economics. Equilibrium occurs when opposing forces balance each other out. In economic terms, these forces are supply and demand, where supply represents the quantity of a good or service that producers are willing to sell at various prices, and demand represents the quantity that consumers are willing to buy at those prices.

In operations of each market:

• In the goods and services market, producers supply goods and consumers (including businesses, government, and households) purchase those goods. The price level affects consumer purchasing power and producer profitability, making the market self-regulating over time.
• The labor market is the platform where labor is bought and sold. Here, workers supply labor, and firms demand labor. Wages are the "price" of labor. If wages are too high, there is an excess supply of labor (unemployment); if wages are too low, there is an excess demand for labor (labor shortages). Classical economists believe that the labor market should clear at the equilibrium wage.
• In the financial market, households typically supply funds through savings, while businesses demand funds for investment in capital. The interest rate coordinates this market by varying in response to change in the levels of saving and investment. The interest rate helps to regulate the flow of capital and thus influences economic growth.

Understanding these markets and their equilibrium prices is vital to grasping how classical economists viewed the functioning of an economy without the need for external intervention, relying heavily on the idea that markets are self-correcting.