Chapter 11 Competing Macro Theories and Issues
Full employment was a norm of capitalism
and Laissez-faire (hands-off)
government policy was best.1 video
II. Classical Economics Say's LAW, Supply created factor income to clear the market and Price-Wage Flexibility, factor prices adjust downward 1 video
III. Keynesian Economics Equilibrium could settle and stay at high unemployment requiring government deficits eventually followed by surplus 1 video
IV. Classical v Keynesian Classical: aggregate supply very inelastic, Keynes AS very elastic 1 video
V. Quantity Theory of Money Changes in the money supply would only affect price and not economic activity. 2 videos
VI. Monetarism Changes in the money supply are both a necessary and sufficient condition to cause inflation. 3 videos
VII. New Classical Economics Market forces not government manipulation of AD and the money supply control economic activity. 2 videos
VIII. Supply-side Econ 3 videos
X. Great Recession Analyzed 2 videos
X. Additional Learning Materials
XI. Schools of Economics Flowchartomists Increase Aggregate Supply not Government Spending to enhance economic growth.
I. Capitalism Theories Overview
A. Classical economics
1. Dominated philosophically during the late 18th, 19th and early 20th centuries.
2. First defined by Adam Smith in The Wealth of Nations - Wikipedia published in 1776.
3. Two primary beliefs
a. Full employment was a norm of capitalism.
b. Laissez-faire (hands-off) government policy was best.
B. Keynesian economics
1. Macro equilibrium could settle at an unacceptable level of unemployed resources.
2. Government intervention could be required to fully employ resources.
C. Monetarism states changes in the money supply are both a necessary and sufficient
condition to cause inflation.
D. New Classical economics states market forces and not government manipulation of
aggregate demand and the money supply to control economic activity.
1. Supply-side economics - Wiki discussed in chapter 16, stated emphasizes increasing
aggregate supply rather than increasing aggregate demand.
2. Freiburg School of the Austrian School developed in 1930's Germany after their great
inflation, is followed by Angela Merkel and stresses free markets with rigorous regulation.
E. Overview Video
II. Classical Economics
A. Basic philosophy
1. The economy is self-adjusting, government doesn't have to interfere.
2. Except for unusual circumstances (war, speculative crises), full employment would be the norm.
B. Two basic theories
1. Say's law
a. Supply created enough factor income to clear the market
1) Inventories will not accumulate.
2) An excess inventory slowdown which causes unemployment was not a necessity.
b.Savings is not a leakage because interest rates adjust to insure saving is borrowed and invested (spent).
1) Leakage describes the loss of a variable required to maintain a state of equilibrium
(stable level of economic activity).
2) Interest rates drop when savings increase to insure savings is invested and there isn't leakage.
c. Say's law - wiki has more information
d. Will Say’s law stay dead? (Rumplestatskin, Macro Business 03/12/13
2. Price-Wage flexibility
a. During periods of slow economic activity wage rates would fall and everyone
wanting to work could find work.
b. All factor prices, not just wages, would adjust downward and all factors would
be fully employed. "Real" factor prices would therefore remain constant.
C. In France, John Baptist Say produced a very superior work on the subject of Political
III. Keynesian Economics
A. The Great Depression discredited classical economics as equilibrium settled and stay at high unemployment.
B. John Maynard Keynes
1. Wrote The General Theory of Employment, Interest, and Money (1936).
2. Disagreed with Say's Law: savings may not be invested.
a. Interest rates are not the sole determinate of savings and investing.
b. Saving and investment are done by different people with different motives.
Saving may not equal investment causing goods to go unsold and inventories
c. Saving is based upon "liquidity preference," the need to hold money
1) Transactionary Motives: for every day use.
2) Speculative Motives: save because prices may drop (Japan in late 1990's).
3) Precautionary Motives: save for uncertainty (recession, oil prices).
d. Investment decisions are based upon profit expectations and interest rates
e. Money balances (savings) are also important in determining aggregate demand.
with Price-Wage Flexibility: that prices would
adjust downward insuring all resources are fully employed.
Great Recession data proved Keynes still correct.
see wage growth and unemployment, wages did not
adjust. 7/16/13, Global Economic Intersection and
Why are wages sticky
4. Use deficit spending to stop recessions with a surplus
to slow inflation with budget balanced over cycle.
5. Keynesian Thinking Kahan Academy video
Keynes argued against a return to the gold standard after the war.
IV. Classical vs. Keynesian
A. Classical explanation
1. Prices are flexible, output is stable.
2. Changes in AD cause prices to change, AS determines Real GDP.
| B. Keynesian explanation
1. Output adjusts, prices are stable.
2. Changes in AD cause changes in employment and Real GDP.
| C. Aggregate supply over the
1. QU represents a recessionary level of Real GDP.
2. QF represents a full-employment level of Real GDP.
3. Aggregate supply - Wikipedia
| D. Manipulating equilibrium
1. Classical economists didn't see a need as Real GDP was fixed..
2. Keynesian economists want to manipulate AD by changing
C + I + G + XN to maintain noninflationary full employment.
3. Aggregate demand - from Wikipedia has a more complete
explanation of the Keynesian view.
E. Comparing Classical and Keynesian macro models
1. Classical and Keynesian Economics is a concise narrative of this material.
2. Aggregate Spending Model from Dr. Barbara Mikalson, Rio Hondo College
3. Elmer G. Wiens: Classical & Keynesian AD-AS Model -
An on-line, interactive model of the Canadian Economy.
4. Khan Academy Keynesian vs. Classical Economics video
V. The Quantity
Theory of Money
A. Represents the basic theory behind macroeconomics prior
to the Keynesian Revolution
B. Believed that changes in the money supply would only affect
price and not economic activity.
C. The equation of exchange
MV = PT
Money Supply X Money Velocity = Average Price Level X Transactions
1. Velocity of money is how often the money supply is spent.
A. Monetarists believe that changes in the money supply are
both a necessary and sufficient condition to cause inflation.
B. If AD was low, increasing the money supply would only
increase short-run economic activity.
1. Eventually short-term expansion stops and increasing M
only adds to inflation.
2. Public anticipation stops the process from being repeated.
3. Monetarists believe that government involvement in the
economy, especially monetary intervention, increases the
magnitude of the business cycle.
C. Keynes believed changing the money supply would affect
interest rates which would affect investment which in turn
would affect Real GDP
D. To some degree monetarism is an extension of classical
economics. Its advocates believe that a competitive market,
free from government interference, results in economic
stability and a reasonable growth rate.
E. For more on Monetarism visit The Concise Encyclopedia of
Economics from Library of Economics and Liberty and
History of Economic Thought Website
F. Extra Stuff
1. Privatize the Gains, Socialize the Losses
is a concise history of our 20th century monetary system.
2. Austrian School of Economics are monetarists whose
theories are followers by conservative Europeans.
Video 1 Video 2
3. Modern Monetary Policy vs. The Austrian Society video
4. Inflation, Fear of Inflation an Public Debt Video Princeton
professor and Nobel Laureate Christopher A. Sims 9/2/14
5. Bill Mitchell Demystifies Modern Monetary Theory
New Classical Economics
A. Lead by Milton Friedman - wiki , these economists revived the
quantity theory of money. See Milton Friedman from Cato Institute
1. Milton Friedman Video on Greed from You Tube
2. Milton Friedman Video 30 minute interview on Open Mind
B. Market forces and not government manipulation of aggregate
demand and the money supply control economic activity.
C. This economic school of thought has much in common with
those who believe in Rational expectations.
1. This recently formed school does not assume market
participants have perfect knowledge.
2. It assumes market participants will learn from experience
and use current information to predict and adjust to an
3. The result is not the disequilibrium of Keynesian economics
with its inflationary and deflationary gaps but a constant
equilibrium with economic behavior adjusting to be compatible
with different levels of economic activity.
4. As with the classical school, the new classical school, monetarist,
and those believing in rationalist expectation feel government
involvement in economic activity is not beneficial.
D. Reasons for self-correction nature of capitalism
1. Wages are Inflexible downward as employers face a minimum
wage and lower wages cause low morale and less efficiency.
Robert King: The Concise
3. Critique of neoclassical economics, did anything change 2/26/14
4. New Classical Macroeconomics from Wiki
VIII. Supply-side Economists
A. Slow economic growth and high inflation of the 1970's caused
some economists to emphasize increasing Aggregate Supply.
B. Stagflation and the Rise of Supply-Side Economics.
C. Video for and Video against 2 min. each
D. Reagan Revolution 14 min.
IX. Great Recession Macro Theories
A. U.S. has successfully used Keynesian economics to quickly
negate the recession, will inflation follow?
B. Germany's enforcing Austrian School austerity and slow growth
in the money supply for Europe has resulted in recessions and
C. Great Brittan is still in or close to recession because of austerity
and an easy money policy has yet to work. Economist Magazine
D. Cheat Sheet for Understanding the Different Schools of Economics
1. Quick History 11 min
2. Financial Mediation video follows the money 13 min.
Federal Reserve in Action
X. Additional Learning MaterialsC
A. Readings, Videos, Podcasts
1. Reconciling Hayek and Keynes short article 6/7/14
2. GDP A Brief But Affectionate History 7/20/14
3. Democratic Capitalism vs. Capitalistic Democracy
4. History of New Keynesianism/
5 How Laissez Faire Economics Lead to Inequality, Recession
6. Stagflation and the Rise of Supply-Side Economics:
the brake-down of the Phillips curve.
7. Progression of Economic Theory from Classical to Keynesian back to Classical to ? 9 min
8. Great Recession from a Classical-Keynesian View
from Roger Farmer Pepperdine School of Public Policy
a. Who are the Academic Scribblers 9.11
b. Refining Cassical Economics 9.29
c. Effect of the Great Depression 9.14
d. 1970's oil shock shocks the world of economics 8.52
e. How bad is the economy and where is it going 7.41
9. Crash Course in Non-Equilibrium Economics 6 videos
10. Macro Musings Podcast Claudio Borio one hour
B. Current Political Economic Controversies has an interesting economics section.
Measuring Total Economic Activity
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