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Ch. 11

Classical and Keynesian Economics

The centerpiece of classical economics Say's law- named after Jean Baptiste Say
Classical economic system believes that the economy, if left free from government interference, tends toward full employment
Say's Law states that supply creates its own demand
GDP= C+I= C+S I=S Invensments=savings
Savings greater than investments= unemployment--interest rates would fall
surplus the amount by which the quantity supplied of a product exceeds the quantity demanded at a specific price
Price flexibility would also bring about equilibrium between saving and investing if lower interest rates did not- businesses, unable to sell their entire output, would simply lower prices, and then people would buy everything produced
Business would only make profit if resource prices, especially wages, are reduced
Classical equilibrium when aggregate demand is equal to aggregate supply, and we are at full employment
Aggregate demand curve shows that as the price level declines, the quantity of goods and services demanded rises.
Aggregate demand the sum of all expenditures for goods and services
3 reasons why quantity of goods purchased declines as price level increases 1. the real balance effect 2. interest rate effect 3. the foreign purchases effect
Real balance effect the influence of a change in your purchasing power on the quantity of real GDP that you are willing to buy
Interest rate effect when a rising price level pushes up interest rates, which in turn lowers the consumption of certain goods and services and also lowers investment in plant and equipment
Foreign purchases effect occurs when our price level rises relative to the price levels in other countries, making American goods more expensive and causing our exports to decline
Aggregate supply the nation's total output of goods and services
Long-Run aggregate supply curve Why is this a vertical line? 1.In the long-run, the economy operates at full employment 2.In the long-run, output is independent of prices
Short-run Aggregate supply curve Why does it sweep upward to the right? Because business firms will supply increasing amounts of output as prices rise
Why does the Short-run AS curve eventually become vertical? Because there is just so much land, labor, and capital
Beyond full employment is only possible in short term
founder of classical economics adam smith
John Maynard keynes believed "what is saving and investment were not equal. saving and investment are done by different people for different reasons" he questioned if wages and prices were downwardly flexible "we are not always at, or tending toward, full employment"
Keynes believed 3 possible equilibriums existed below full employment, at full employment, and above full employment
As the economy begins to recover, output can be raised to about 4.7$ trillion without any increase in prices. why? Because unemployed workers would be happy to work for the prevailing wage, so wage rates would not have to be raised to entice people back to work.
What causes inflation Excessive demand
demand-pull "too much $ chasing too few goods"
the key to keynes analysis the role of aggregate demand
Keynesian economics believed the private economy was inherently unstable and government intervention was necessary. Aggregate demand if our economy's prime mover
In the Keynesian model, what causes a recession? a decline in profit expectations, aka the marginal efficiency of capital
both classical and keynesian are always tending toward equilibrium, where aggregate demand=aggregate supply
Equilibrium aggregate demand=aggregate supply
when aggregate demand exceeds supply inventories decline-prices rise
GDP identical to aggregate supply
2 ways to increase aggregate supply by increasing output and prices
disequilibrium when aggregate demand does not equal aggregate supply
when aggregate supply exceeds demand inventory rises
For it to be in equilibrium... aggregate demand (C+I) must equal the level of production (aggregate supply) for it to be in equilibrium. If not, aggregate supply must adjust
Keynesian recessions are not temporary, the private economy does not automatically move toward full employment. It is necessary for the government to intervene, or spend money
New Deal made by president Franklin Roosevelt in attempt to get out of the Great Depression. Then he raised taxes, cut government spending, and cut the rate of growth of the money supply
Keynes believed that demand create its own supply
Created by: ltameirao



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