Transcript The Self Regulating Economy - Long Beach Unified School

Ch. 8: The Self
Regulating Economy
James R. Russell, Ph.D., Professor of Economics & Management, Oral Roberts University
©2005 Thomson Business & Professional Publishing, A Division of Thomson Learning
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Classical Economists and
Say’s Law
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Say’s Law: supply creates its own
demand.
Implied in Say’s Law: there cannot be either
a general overproduction or general
underproduction of goods.
Say’s Law still holds in a money economy,
where individuals sometimes spend less
than their full incomes. This argument was
partly based on the assumption of interest
rate flexibility.
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Classical Economist and
Interest Rate Flexibility
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For Say’s Law to hold in a money economy,
funds saved must give rise to an equal
amount of funds invested.
Interest rates will adjust to equate saving
and investment.
Any fall in consumption (and consequent
rise in saving) will be matched by an equal
rise in investment.
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Exhibit 1: The Classical View of the
Credit Market
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Exhibit 2: The Classical View of Say’s
Law in a Money Economy
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Classical Economists on
Prices and Wages
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Classical economists
believed most, if not
all, markets are
competitive.
Prices and wages will
adjust quickly to any
surpluses or
shortages and
equilibrium will be
quickly reestablished.
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Self-Test

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Explain Say’s law in terms of a barter
economy.
According to classical economists, if
saving rises and consumption
spending falls, will total spending in
the economy decrease? Explain.
What is the classical position on prices
and wages?
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Exhibit 3: Real GDP and Natural Real
GDP: Three Possibilities
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Recessionary Gap: Real GDP is
less than the Natural Real GDP
Inflationary Gap: Real GDP is
Greater than Natural Real GDP
Long-Run Equilibrium: Real
GDP is Equal to Natural Real GDP
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Exhibit 3: Real GDP and Natural Real
GDP: Three Possibilities
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The Labor Market and The
Three States of the Economy
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Recessionary Gap: the unemployment
rate is higher than the natural
unemployment rate (surplus of labor)
Inflationary Gap: the unemployment rate
is lower than the natural unemployment rate
(shortage of labor)
Long-Run Equilibrium: the
unemployment rate is equal to the natural
unemployment rate.
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Exhibit 4: The Physical and
Institutional PPFs
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Self-Test
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What is a recessionary gap? an
inflationary gap?
What is the state of the labor market
when the economy is in a recessionary
gap? in an inflationary gap?
If the economy is in an inflationary
gap, locate its position in terms of the
two PPFs discussed in this section.
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What happens if the Economy is
in a Recessionary Gap?
1.
2.
3.
4.
5.
6.
Recessionary gap
Unemployment > Natural
Unemployment
Surplus in labor market
Wages to fall
SRAS shifts to the right
Economy moves to long-run
equilibrium.
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Exhibit 5: The Self-Regulating
Economy: Removing a
Recessionary Gap
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What happens if the Economy is
in an Inflationary Gap?
1.
2.
3.
4.
5.
6.
Inflationary gap
Unemployment < Natural
Unemployment
Shortage in labor market
Wages rise
SRAS shifts to the left
Economy moves to long-run
equilibrium.
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Exhibit 6: The Self-Regulating
Economy: Removing an
Inflationary Gap
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Self-Regulating Economy:
A Recap
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Flexible wages (and
other resource
prices) play a
critical role.
Classical, NewClassical, and
Monetarist believe
the economy is selfregulating
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Policy Implications of Believing
the Economy is Self-Regulating
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Laissez-faire: Aa
public policy of not
interfering with market
activities in the
economy.
Some economists
believe the
government does not
have an economic
management role to
play.
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Exhibit 7: Changes in a SelfRegulating Economy: Short Run
and Long Run
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Self-Test
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If the economy is self-regulating, what
happens if it is in a recessionary gap?
If the economy is self-regulating, what
happens if it is in an inflationary gap?
If the economy is self-regulating, how do
changes in aggregate demand affect the
economy in the long run?
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Coming Up (Ch. 9): Economic Instability
A Critique of the Self-Regulating Economy
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