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Classical Economists' Thoughts on the Phillips Curve

  • Classical economists suggest that any attempt to push unemployment below its natural rate would cause accelerating inflation, with no long-term job gains.
  • The only way to reverse this process would be to raise unemployment above the NRU so that workers revised their expectations of inflation downwards, and the economy moved to a lower short-run Phillips curve.

Classical View on Crowding Out

Keynes' Thoughts on the Phillips Curve

  • Crowding out is likely to happen when the economy is near full employment. Classics agree that when interest rates increase, savings will increase. They support the theory of crowding out.
  • Keynes suggested that since prices don't fully adjust in the short run, changes in demand can affect inflation and unemployment.
  • Higher than expected inflation should be met with lower unemployment.
  • Lower than expected inflation should be met with higher unemployment.

Crowding Out: Definition

Keynes' View on Crowding Out

In order to fight recession, the government has to borrow from people. In turn this decreases savings and investments, driving interest rates up. Private spending is "crowded-out" by the governments actions.

  • Reject the theory of crowding out, he does not believe government spending will crowd out private investment
  • Keynes believes that the higher interest rates will actually result in lower wages, and ultimately lower savings. he believes in the opposite of crowding out.

Equilibrium

Keynes' View on Inflation/Unemployment

  • Keynesians do not think that the typical level of unemployment is ideal—partly because unemployment is subject to the sudden change of aggregate demand, and partly because they believe that prices adjust only gradually.

Monetarists' View on Macroeconomic Forces

  • A change in demand will change the prices not the real output.

Inflation

  • Keynesians typically see unemployment as both too high on average and too variable.
  • The money supply influences the output in the short run and the price level over long periods.
  • Some Keynesians are more concerned about combating unemployment than about conquering inflation. They have concluded that the costs of low inflation are small

How Classical Fixes Johnny Economy

Recession

  • Classical economists believe that if the market economy is at disequilibrium then the market will correct itself
  • They believe this because " IF markets are competitive, then they will achieve efficient production and efficient distribution." (Jims Guide)

Keynes' Background

  • John Maynard Keynes 1883-1946
  • Keynesian General Theory 1936
  • He was influenced by many things but the main one was the Great Depression
  • This caused him to realize that demand was what pushed employment levels not supply and that government should help push employment and growth as well

Classical View on Inflation/ Unemployment

The Importance of Expectations, Wages, and Prices

  • Economists feel that the economy is self regulating and that it's capable of achieving natural level of RGDP when the economy is fully employed
  • According to Keynesian macroeconomics, low demand for products(low spending) results in unemployment- and therefore an economy in trouble. With less consumers spending money, and unemployment on the rise, wages will fall.
  • Consumer's expectations-or what consumers predict will occur- decide their spending.
  • As less money is spent and unemployment rises, price levels will drop- resulting in a recessionary gap.
  • Each of these three factors directly affect the health of the economy and affect each other.

Classical Economic Theory

How Keynes'Fixes Johnny Economy

Classical theory is based on the results of distinguished economists in the 1700s and 1800s. This theory portrays how the economy can regulate itself (laissez-faire)

Keynesian Economics

Supply Side Economics

  • Keynesian theorist have a different approach. They believe that when the macro economy is in disequilibrium that the economy will remain there for a prolonged amount of time.
  • Therefore these economists support government intervention to decrease unemployment and increase growth.

Keynesian theory is based highly on government intervention to regulate the economy, these economists feel it is necessary at all means.

Ronald Reagan came up with the idea that greater tax cuts for investors provide incentive to save and invest which trickles down into the overall economy.

Supply side includes tax policy, regulatory policy and monetary policy.

They also think producers set the pace of the economy not the consumers.

Continued

  • To bring the market back to equilibrium after a recession a Keynesian would recommend expansionary fisical policies such as:
  • Decrease in taxes
  • Increase in government spending
  • To bring the market back to equilibrium after a inflation a Keynesian would recommend a contractionary fiscal policies such as:
  • Decrease in government spending
  • Increase in taxes

Say's Law

An economic rule that says that production is the source of demand. According to Say's Law, when an individual produces a product or service, he or she gets paid for that work, and is then able to use that pay to demand other goods and services.

Macroeconomic Theory

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