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46 Cards in this Set
- Front
- Back
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• Keynesian Economics
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opposing or complimentary to a market-oriented economy
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o Keynesian View of recession
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• Aggregate Demand is not high enough for firms to reach full employment
• Macro economy may adjust slowly to shifts in aggregate demand because of stickiness of wage prices |
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o Aggregate Demand
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total demand for goods in an economy
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o Coordination argument
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decline in own wage – OK – if everyone experiences it
• Market Oriented Economy – no way to do this |
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o Menu Costs
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costs that firms face when changing prices
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• Two Keynesian Assumptions (AS-AD model)
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o Importance of AD in causing recession
o Stickiness of wages/prices |
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o Permanent Income Hypothesis
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when individuals think about how much to consume and consider how much income they will make in their lifetime
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When to save or borrow
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low interest rate borrow
high interest rate save |
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o Expected rate of return based on
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• Investment opportunities
• Future economy • New technology |
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• What causes consumption to shift
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income
taxes future incomes whether to save or borrow |
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• What causes government demand to shift
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o Make decisions based on politics
o Levels of GDP |
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• reason why AD shifts to left
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o Consumption – rise in tax, income, interest rate, savings, fall in wealth and expected income
o Investment – rise in interest rate, decrease in rate of return and business confidence o Government – fall in spending o Export/Import – rise in price of US goods, fall in foreign demand |
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• Phillips Curve
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o Price wages are sticky and do not adjust rapidly according to Keynesian
o During each economic recession, real GDP is below potential GDP and high unemployment – pressures for inflationary increases in price level also tend to be low o High inflation when unemployment is low |
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o Stagflation
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when an economy experiences stagnant growth and inflation at same time – unhealthy
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Keynesian solution to recession
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use tax cuts and policies to shift AD to the right
stimulate consumption and investments increase government spending |
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When unemployment is low and inflation is high
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increase taxes
decrease in government spending |
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o Pay off
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allows closer analysis on how shifts in demand/spending affect the rest of the economy
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o Expenditure output model
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macroeconomic model in which equilibrium output occurs where the total or aggregate expenditures in the economy are equal to the amount produced; “Keynesian Cross Model”
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o National incomes
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sum of all income received for producing GDP
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o Aggregate expenditure schedule
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total expenditure in economy for each level of real GDP
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o MPC – Marginal Propensity to Consume
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share of an additional dollar of income that goes to consumption
• MPC + MPS = 1 |
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o MPS – Marginal Propensity to Save
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share of additional dollar that goes to saving
• MPC + MPS = 1 |
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o Consumption function
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relationship between income and expenditures on consumption
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o Shift in consumption function
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• Up – tax cut so consumer spends more
• Down – tax raise so consumer spends less |
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• Investment as a function of National Income
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o Investment decisions – forward – looking based on Rate of Return
o Doesn’t change with current national income |
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• Combined Aggregate Expenditure Function
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o AE line = C+I+G+X-M
o Equilibrium – NI=AE |
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o Recessionary gap
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gap in output between an economy in recession and a potential GDP
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o Inflationary gap
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when an economy has output above potential GDP the cap from that level of output to potential GDP
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o Multiplier Effect
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how a given change in expenditure cycles repeatedly through the economy, and thus, has a larger final impact than the initial change
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o Multiplier
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total increase in AE % original increase
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• Calculating Multiplier
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o Fraction of expenditures recycled (f)-
f=1-whatgoesintotaxes – whatgoesintosavings – whatgoesintoimports o Multiplier affects government spending and any economic change |
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• Multiplier Trade Off
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o Higher multiplier – more unstable economy
o Lower multiplier – more stable economy |
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• The Neoclassical perspective
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emphasizes that the economy seems to rebound in the long run to its potential GDP and natural state of unemployment
wages/prices will adjust in a flexible manner |
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o Long run neoclassical model
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as economic output rises above potential GDP, level of unemployment falls
o High demand for labor drives up wages o Rise of wages = upward shift in short-run Keynesian aggregate supply curve |
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o During unemployment
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• Can old on pay increases
• Can replace high pay workers with those willing to work for lower prices |
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o Rational Expectations - and at macro level
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the theory that people form the most accurate possible expectations about the future that they can using all the information available to them
• At macro level – theory of rational expectations – If AS curve is vertical over time people should expect this pattern |
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o Adaptive expectations
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the theory that people look at past experiences and gradually adapt their beliefs and behavior as circumstances change
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• Policy implications of the Neoclassical Perspective
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o The economy has a self-correcting tendency to move back to potential GDP
o Encouraging long-term growth – more important fighting recession |
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skeptics of neoclassical economists
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skeptical of the governments ability to manipulate aggregate demand skillfully and in a timely manner – focus attention on long run productivity growth – economy’s investments in human capital, physical capital and technology operating together in a market-oriented environment that rewards innovation
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o 2 categories of unemployment
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Cyclical
natural |
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• Cyclical
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economy producing below potential GDP – less incentive to hire (caused by recession
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Natural
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employment rate created by the forces of supply and demand in the labor market, even when the economy is at its potential GDP
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Rise in neoclassical AD
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leads to inflationary pressures
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• Neoclassical Phillips curve trade off
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o Long run as curve – vertical
o Unemployment rate is the natural rate o Milton Freidman – “There is always a temporary trade off between inflation and unemployment; no permanent trade off.” o Keynesian Perspective – focus on getting level of AD right in relationship to an upward sloping aggregate supply curve – AD should be adjusted so that the economy produces at its potential GDP, not so that cyclical unemployment results and not so high that inflation results |
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• Says Law
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supply creates demand
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• Keynes Law
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demand creates its own supply
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