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Macroeconomic Theory

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Olivia Terrell

on 4 January 2013

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Transcript of Macroeconomic Theory

Alicia F, Olivia T, Jordyn C, Balya S. Disputes of Macroeconomic Theory Different Approaches Monetarism Monetarist: Economist who believes the economy's performance is determined by changes in money supply.

Therefore, a governing body can manipulate the health of the economy by changing monetary policy.

Thus, changes the money supply can quell inflation. Milton Friedman Believed in the quantity theory of money: the idea that price level depends on the money supply.

He believed that the solution to inflation and short-run fluctuations in unemployment and real GNP was the money-supply rule. If the Fed increased the money supply at the same rate as real GNP increases, inflation would disappear. Margaret Thatcher Thatcher was the prime minister of the UK in the

She thought, being a monetarist, that if she
controlled the money supply she could tame inflation.

She outlawed many labor unions so that the total
money supply, being paid out to workers at a high
minimum wage, would decrease. She also cut
government spending.

These manipulations of variables affecting
money supply reduced inflation
in Britain. But... Once people adjust to a higher inflation rate, unemployment will slowly come back up. Friedman says to keep unemployment permanently low, there would have to be a higher and permanently accelerating inflation rate. Supply-Side Economics Production is the most important component of economic growth.

"A supply-sider believes that producers and their willingness to create goods and services set the pace of economic growth." (Almost) Vertical Supply Curve An increase in demand
(Prices go up) Therefore, the only thing that will actually increase output (and therefore lower prices) is an increase in supply. What do supply-siders want? There are three pillars: Lower marginal tax rates (including lower capital gains taxes). It will, in theory, increase worker productivity and create more product.

Less government interference with the free market. Government spending, while increasing demand, will not make a real impact on growth.

Don't let the Fed manipulate money supply. It might stifle growth by deflating the money supply. Keynesian Economics This type of economic theory states that growth and stability of the economy can be ensured by active government intervention. Government intervention can come in the form of government spending and tax cuts to grow the economy and government spending and tax raises to fight inflation. Classical Economics Classical economic theory was started by Adam Smith in the 18th century. This economic theory is concerned with economic growth by free competition and laissez-faire, meaning if you leave the economy alone it will fix itself. Economic Conditions That Set up Keynes Work Classical

The costs of production are always restored by the money received from the sales caused by the aggregate demand Keynesian

Keynes disagree saying this can only be true if the individuals savings exactly equal the aggregate investment Classical

Any problem in an economy can get fixed by itself is a theory called the theory of the invisible hand. Keynesian

Since prize adjustments are not possible easily, the idea of correcting market based on flexible prices is not possible either. Classical

During a period of crisis, government intervention is not necessary Keynesian

During a crisis, monetary and fiscal policies is an absolute necessity Classical

Aim to solve long term problems costing some short term loses Keynesian

Short run problems should be solved before worrying about long term problems. Classical

The changes in interest rates would adjust the surplus of loanable funds and bring the economy back to an equilibrium Keynesian

Interest rates do not perfectly rise or fall in proportion to the demand and supply of loanable funds. They can overshoot or undershoot at times unemployment and inflation
Keynes argued in a recession, people responded to the threat of unemployment by increasing saving and reducing their spending this contributes to an even bigger decline in aggregate demand and GDP. Classical Economist view The point where the short-term Phillips curve intersects the long-term Phillips curve is the expected inflation. To the left side of that point, actual inflation is higher than expected and to the right actual inflation is lower than expected. Basically, unemployment below the natural level leads to inflation higher than expected and unemployment higher than the natural level leads to inflation lower than expected. Keynesian Economists view Generally will stress the importance of reducing unemployment rather than inflation. Changes in aggregate demand, whether anticipated or unanticipated, have their greatest short-run impact on real output and employment, not prices. This idea is portrayed in the Phillips curves that show inflation changing only slowly when unemployment changes. Keynesians believe the short-run lasts long enough to matter. They often quote Keyne's famous statement "In the long run, we are all dead" to make the point. Keynesians and crowding out view Many Keynesians begin to wonder if the Phillips curve really exists because it contradicts economic reality. Keynesians reject the theory of crowding out presented by monetarists. Keynesians say that if there is a sharp rise in private sector borrowing, government spending can off set this decline in spending. In a recession, government intervention can stimulate aggregate demand and real output through government borrowing and higher government spending. Therefore kynesians advocate expansionary fiscal policy in a recession. Classical and crowding out view Does not apply to this theory because in classical economics they do not believe in government interference. Classical economists believed that the crash of 1929 was natural and that it was the nature of the business cycle to go through ups and downs. As the depression worsened through the 1930s people began to doubt classical economic theory. Keynes suggested that the Great Depression was caused by a failure of aggregate demand, which created a new equilibrium and increased unemployment. In order to get the economy to boost, Keynes said that the government should increase spending which would increase the aggregate demand.
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