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Macroeconomic Theories

Macroeconomic Theories. Classical vs Keynesian Economics. Economic Schools of Thought. NeoClassical Economics |--------------------------------|. Classical Economics |----------------------------|. Keynesian Economics |----------------------------|. 1800 1929.

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Macroeconomic Theories

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  1. Macroeconomic Theories Classical vs Keynesian Economics

  2. Economic Schools of Thought NeoClassical Economics |--------------------------------| Classical Economics |----------------------------| Keynesian Economics |----------------------------| 1800 1929 1980 2008 1936 1979 Housing Bubble Now What? Great Depression? Prices were not flexible! What Now? Keynesian Economics did not help here!

  3. LRAS1 Price Level SRAS1 Real GDP AD1 Stock Market suddenly falls 25% Gov’t Intervention with Fiscal Policy “Self Regulation”? Use Expansionary Fiscal Policy ↑ Gov’t Spending & ↓ Income Taxes Impact: G ↑ & C ↑ => AD ↑ --------------- P1 E1 --------- P2 E2 -------- AD2 Y2 Y1

  4. Reading • Read Keynesian Handout

  5. Economy is at Full Employment when AS turns Vertical AS Price Level Classical Range Intermediate Range Keynesian Range AD Real GDP

  6. CLASSICAL VIEW • Markets are naturally self regulating • Nogovernment intervention necessary • Recessions are temporary • Wages & prices are flexible • Against minimum wages, welfare, government assistance • Great Depression challenged Classical View

  7. KEYNSIAN VIEW • Economy is inherently unstable • not self regulating • Recessions can be long & permanent • Major government intervention necessary • Wages and prices are fixed/sticky • AS curve is very flat (fixed) or upward sloping (sticky) • Support welfare & government assistance • Stagflation challenged Keynesian view

  8. Reconciling 2-Views • Most economists believe classical theory describes world in the long run but notshort run • Prices, Wages & interest rates are at least somewhat sticky in the short run • Keynesian economics focuses on AD and failed to explain the Stagflation of the late 1970’s

  9. AD2 However, Wages did not adjust Classical Model Failure: The Great Depression Real GDP ↓ 27% Unemployment 3% → 25% Price Levels fell Price Level LRAS2 AD1 Real GDP

  10. “Supply Shock” in SRAS • A sudden shift in short run aggregate supply: • Stagflation is caused by adverse supply shock • SRAS shifts left • Output falls & Price level rises • period of recession and inflation. • Example:late 1970’s in USA (oil crisis) • Challenge:Policymakers who can influence AD cannot offset both simultaneously (Output falling & Price level rising) • Keynesian economics “failed”! SRAS2

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