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Economic Instability: A Critique Of The Self Regulating Economy

Economic Instability: A Critique Of The Self Regulating Economy. Questioning The Classical Position. Keynes and Keynesian thought the classical view of the economy was wrong. Questioning The Classical Position (continued). The classical: 1. Say’s law holds

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Economic Instability: A Critique Of The Self Regulating Economy

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  1. Economic Instability: A Critique Of The Self Regulating Economy

  2. Questioning The Classical Position • Keynes and Keynesian thought the classical view of the economy was wrong.

  3. Questioning The Classical Position (continued) • The classical: 1. Say’s law holds insufficient demand in the economy is unlikely. 2. Wages, prices, and interest rates are flexible. 3. The economy is self regulating.

  4. Keynes’s Criticism Of Say’s Law In A Money Economy • Classical economists: - If consumption spending fell because saving increased, then total spending would not fall because the added saving brings more investment spending, (Keynes disagreed)

  5. Keynes’s Criticism Of Say’s Law In A Money Economy (continued) • Keynes’s view of Say’s law in a money economy: a decrease in “consumption” and subsequent increase in “saving” may not be matched by an equal increase in “investment.” Thus a decrease in “total expenditures” may occur. Exhibit 1 Page 197.

  6. Keynes’s Criticism Of Say’s Law In A Money Economy (continued) • Classical: “saving” and “investment” depend on the interest rate. Keynes: “saving” and “investment” depend on a number of factors that may be far more influential than the interest rate.

  7. Keynes On Wage Rates • Classical: if unemployment rate is greater than the natural unemployment rate, a surplus exists in the labor market (Table Page 184), thus wage rate fall. Keynes: did not believe above statement adjusted so simple. Wage rates may be inflexible in a downward direction. Exhibit 2 Page 199

  8. New Keynesians And Wage Rates • Efficiency wage models: sometimes in the best interest of business firms to pay their employee higher than equilibrium wage rates.

  9. Keynes On Prices • Classical: prices in the economy are flexible, move up and down in response to market forces. Keynes: not always competitive enough to allow prices to fall.

  10. Exhibit 3 Page 200 How long it takes for wage rates and prices to fall.

  11. The Simple Keynesian Model • Assumptions: 1. The price level is constant until economy reaches its full employment (Natural Real GDP). 2. No foreign sector (closed economy) TE = C + I + G 3. Monetary side of the economy is excluded.

  12. The Simple Keynesian Model (continued) • The consumption function: 1. “Consumption” depends on “disposable income”. “Disposable income” = income – taxes 2. Consumption and disposable income move in the same direction. 3. When disposable income changes, consumption changes by less. C = Co + (MPC)(Yd) MPC = marginal propensity to consume MPC = delta C / delta Yd Co = autonomous consumption, independent of disposable income.

  13. The Simple Keynesian Model (continued) • Consumption and saving: S = Yd – [Co + (MPC)(Yd)] MPS = delta S / delta Yd MPC + MPS = 1

  14. The Simple Keynesian Model (continued) • Multiplier: - to obtain the overall change in total spending. m = 1 / ( 1 – MPC ) Change in total spending = multiplier x change in autonomous spending

  15. The Simple Keynesian Model In The AD-AS Framework • Shifts in the Aggregate Demand Curve: - There are C, I, G that can shift the AD curve. - Co increases…..C increases…………… AD increases Exhibit 5 Page 207.

  16. The Simple Keynesian Model In The AD-AS Framework (continued) • The Keynesian Aggregate Supply Curve: - has both a horizontal section and a vertical section. Exhibit 6 Page 207.

  17. The Simple Keynesian Model In The AD-AS Framework (continued) • The economy in a recessionary gap: - Keynes believed the economy could get stuck in a recessionary gap. Exhibit 7 Page 209.

  18. The Simple Keynesian Model In The TE (Total Expenditure) – TP (Total Product) • Deriving a Total Expenditure (TE) curve: TE = C + I + G Exhibit 8 Page 211. TE curve is upward sloping.

  19. The Simple Keynesian Model In The TE (Total Expenditure) – TP (Total Product) (continued) • What will shift the TE curve?: - TE curve shifts if there is change in C, I, or G. - a rise in C will shift the TE curve upward. - a decline in I will shift the TE.

  20. The Simple Keynesian Model In The TE (Total Expenditure) – TP (Total Product) (continued) • Comparing Total Expenditure (TE) and Total Production (TP): 1. TE < TP, disequilibrium 2. TE > TP, disequilibrium 3. TE = TP, equilibrium

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