Chapter 11 Competing Macro Theories and Issues

I. Capitalism Theories Overview 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 Flowchart
omists Increase Aggregate Supply not Government Spending to enhance economic growth.

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  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

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cartoonstock.com/

 

 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 
            Economy. His arrangement is luminous, ideas clear, style perspicuous, and the whole 
            subject brought within half the volume of [Adam] Smith's work. Add to this considerable
            advances in correctness and extension of principles. Thomas Jefferson, letter to Joseph
            Milligan, April 6, 1816 Friesian School
      D. Free Course Video Great Economists: Classical Economics and its Forerunners

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
                   to increase.
               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.      

Image result for keynesian economic theory cartoons

           3. Disagreed 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

 

 

 

 

 

 

John Maynard Keynes

Keynes argued against a return to the gold standard after the war.

IV. Classical vs. Keynesian Equilibrium  
         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 business cycle
              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.
           2. Transactions is the number in real economic activity
           3. The equation is an identity

                a. Dollars spent = dollars received
                b. MV = Aggregate Demand and 
                    PT = Nominal GDP = C + I + G + XN = GDP
           4. Classical theory stated that V was basically stable and
               that there existed some natural level of growth for T. 
               a. This natural level was a function of individual and 
                    business interaction. 
               b. V and T were essentially unalterable which meant
                    changes in M would change P and not the natural
                    level of T. 
               c. Government should thus refrain from interfering with
                   market activity by adjusting the money supply.
     D. Came into disfavor in the 1930's with the popularity of
          Keynesian economics which stated that real output 
          could be changed by affecting aggregate demand.
     E. Additional

          1. Equation Video and Velocity of Money Rather Than Quantity- Diving Prices

          2. Quantity Theory of Money? is a concise narrative.
          3.Quantity theory of money - Wiki
requires algebra.
    
  
4. The money-inflation connection: It's baaaack!

       5. Debt-Deflation from Irving Fisher  was popular in
              the early 1930's though Keynes won. Revisited 
              because of the Great Recession
         6. Monetary theory is non ergodic as data can't be averaged.

 

Image result for money supply cartoons

 

Image result for money supply cartoons

 

Editors Note:
Things have happened since the equation of exchange was
developed and they increase current aggregate demand and
run the risk on decreasing AD in the future.
1) Nixon took us completely off gold in early 70's. Money supply
can change up or down without printing so we will never need
inflation caused wheel barrows to carry money.
3) Federal debt, once only used to finance war now finances
social programs.
3) States and companies promise retirement they may not
easily finance in the future. Note the Federal government
is not included as they can print money. For 250 years this
has not been a problem. See
Can We Afford an Almost 20 Trillion Dollar Federal Deficit?

We Afford Federal Entitlements?
Question! How many econometric models incorporate these concepts?

VI. Monetarism
        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

 

Cartoon of the Day: Bailouts! - bankers bailing cartoon 10.11.2016

 
VII. 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 
                expected future. 
            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
           5. What-is-neoclassical-economics

 

Image result for Milton Friedman cartoons

Image result for new classical economics cartoons

  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
     
         slow growth.
         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

         E. Videos
              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 Sc
ribblers 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. 

Macro Chapters

8) Measuring Total Economic Activity 
9) The Business Cycle

10) Macro Equilibrium 
11) Competing Macro Theories and Issues
 
10) Macro Equilibrium 
11) Competing Macro Theories and Issues
12 Keynesian Economics: An Expanded View
13 Money, Banking, and the Creation of Money

See

Financial Crisis
The Great Recession
14) Fiscal Policy
15) Monetary Policy  
16) Stagflation % Rise of Supply-Side Economics
17) Budget Deficits
See
Democratic Capitalism vs. Capitalistic Democracy 

  

XI. Schools of Economics Flowchart

 
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