Transcript MODERN ECONOMICS - University of Hawaii

MODERN
ECONOMICS
A Survey of Contemporary
Thought
Based on Schools Briefs in the Economist, 03 November 1990 to 09 March 1991 and
12 February to 02 April 1994.
PARADIGM LOST
• Macroeconomic Analysis: the
Paradigm
• Classic Keynes
• Meltdown
• New Classical/New Keynesian
Schools
Macroeconomic Analysis:
The Closed Economy
Paradigm
r
LM
IS
y
The LM Curve
EQUILIBRIUM IN THE MONEY MARKET
If the interest rate rises, the demand
for spendable money, as opposed to
higher interest, non-spendable assets,
falls. Hence, if we are to experience
equilibrium, the supply must also fall,
an event that occurs if income falls.
The higher interest rate makes
bonds more attractive because
of the yield. But, bond prices are
lower, making them more attractive
also because of the higher
probability of capital gain.
The IS Curve
EQUILIBRIUM IN THE GOODS
& SERVICES MARKET
If income (output) rises, saving &
tax payments rise; demand increases
fall short of the output increases.
This creates an excess supply of
goods & services, which can be
offset by rising demand, an event
that occurs if interest rates fall.
Factors Causing LM to
Shift
Changes in the supply of money.
Changes in the domestic price level
relative to the stock of money.
Changes in the demand for money
or in liquidity preference.
Shifting the LM Curve
r
Similarly, the shift may
be to the right or down
LMif M/P rises. Expansionary
The shift may be considered to the
monetary policy by the FED
left or up if M/P (the real value
or Central Bank.
of the money stock) falls. The
FED’s recent tightening of
monetary policy reduced M
relative to P and put upward
pressure on interest rates.
Economy wide reductions in the
Monetary tightness may
demand for money will also cause
also result from rising
the LM to shift to the right or
demand by the public
down.
to hold money balances.
This is the Japanese
situation today.
y
Factors Causing IS to
Shift
Shifts in the demand curves for
investment or consumption goods relative
to the interest rate or income.
Changes in government spending.
Changes in tax rate policy.
Changes in price levels.
r
Shifting the IS Curve
y
Macroeconomic Analysis:
the Open Economy
Paradigm
DD
E
AA
y
The AA Curve
MONETARY EQUILIBRIUM
If Inland currency appreciates (E falls),
expectation of future depreciation is
stronger. Markets will adjust with
higher Inland interest rates and reduced
demand for money. Income growth, if
forthcoming, will restore money
demand and monetary equilibrium.
The DD Curve
OUTPUT MARKET EQUILIBRIUM
If Inland currency appreciates (E falls),
X - M falls, creating excess supplies in
Inland goods & services markets. Output
reduction, if forthcoming, will eliminate
the excesses.
Factors Causing DD to
Shift
Changes in Government Spending
Changes in Tax Policies
Changes in Investment or Consumption
Changes in Inland price levels
Changes in Outland price levels
Changes in relative Outland/Inland
goods preferences.
Factors Causing AA to
Shift
Changes in the Money Supply
Changes in Inland price levels
Changes in the expected long-run
exchange rate
Changes in Outland interest rates
Changes in real money demand.
Classic Keynes
Demand Side: Functions concerning
investment, consumption, government
demand and net exports.
Supply Side: Functions concerning
labor supply & demand related to the
real wage rate.
The Phillips curve and its inflation/
unemployment trade-off.
CONSUMPTION
ACCORDING TO
KEYNES
C
I
G
CA
45°
C + I + G + CA
C = Consumption
Y = C + I + G + CA
45°
INCOME OR OUTPUT
INVESTMENT (I or G or
CA) GROWTH
C
I
G
CA
45°
C + I' + G + CA
C + I + G + CA
Y' = C + I' + G + CA
Y = C + I + G + CA
45°
Y
Y' INCOME OR OUTPUT
THE GOVERNMENT
BUDGET
r
S
S+T
I+G
I
I&S
The {S + T} & {I + G} Curves:
Assume that Income rises
r
S+T
S'+T'
Lower
interest
rate goes
with higher
income at
equilibrium
points.
If income rises,
saving and tax
payments rise sharply.
However, investment
rises mildly &
government spending
falls (why?)
I’+G'
I+G
I, S, T & G
Labor, Capital & Production:
Full Employment Real Output
At full employment, the
corresponding level of
output (yF) is called Full
Employment Real Output.
Why is the supply curve
backward bending?
W/p
Real
wage
rate
(W/p)F
Supply of Labor
Labor Force
Demand for Labor
NF
{Full Employment}
N
The Complete Model
r
LM
r
IS
yF
y
The Phillips Curve
Inflation
8%
P1
P2
3%
4%
6%
Unemployment
Meltdown
If prices rise, real wages fall inducing an
increase in the quantity of labor demanded.
If labor is oblivious to these changes, the
increased demand will induce an increase
in supply, and unemployment will fall.
Is Labor Oblivious?
Not perfectly rational, but able to
learn from their mistakes. Policies
designed to lower real wages to induce
employment lose effectiveness as
rapidly as labor is able to learn.
That’s fast!