Transcript APEcon Economic Ideologies Lecture

Economic Ideologies
AREAS OF DISPUTE
• WHAT CAUSES INSTABILITY IN THE
ECONOMY?
• IS THE ECONOMY SELF-CORRECTING?
• SHOULD GOV’T HAVE RULE SOR USE
DISCRETION IN SETTING ECON
POLICY?
Classical Economics
• Otherwise known
as Conservative
Economics.
• Emphasizes role of
profit incentives in
creating new
products and
industries.
• Prefers free
market solutions to
economic
problems.
Classical Economics cont’d
• Believes the economy is selfregulating.
• Assumes prices, wages and interest
are (or should be) flexible.
• Believes capitalism promotes
economic growth, innovation,
efficiency and raises standards of
living.
• Believes gov’t policies can crowd-out
business investment and fail because
of timing lags.
• LAISSEZ FAIRE
• ADAM SMITH; RICARDO, MILL, SAY’S
LAW
• NATURAL LAWS OF ECONOMICS
–
–
–
–
PRIVATE PROPERTY/PRIVATE INTEREST
FREEDOM OF TRADE
FULL EMPLOYMENT IS THE NORM
SHORT TERM PROBLEMS FIX
THEMSELVES IN THE LONG RUN
– Say’s Law- supply creates its own
demand
Liberal Economics
• Otherwise known
as Keynesian
Economics.
• Believes free
markets do not
solve high
unemployment.
• Believes that
instability is
inherent in
capitalism.
Liberal Economics cont’d
• Believes demand for goods is central for
understanding the rise or fall of
production.
• Emphasizes inflexibility of prices and
wages because of institutional constraints.
Maintains that inflexibility is necessary or
not easily changed.
• Believes the economy can remain stuck in
recession or depression.
• Believes capitalism can be “repaired” by
governmental action.
KEYNESIAN ECON CONTINUED
•
•
•
•
ECONOMY NOT SELF CORRECTING
AGGR. DEMAND DETERMINES OUTPUT
WAGES INFLEXIBLE DOWNWARDS
ACTIVE GOV’T INTERVENTION FIXES
AN UNSTABLE ECON.
• INSTABILITY IN THE ECONOMY
CAUSED BY INVESTMENT CHANGES
Radical Economics
• Otherwise known as
Marxian Economics
or Communism.
• Emphasizes built-in
structural problems
that will cause
capitalism to
change.
• Emphasizes the
importance of
social classes:
workers and
owners.
Radical Economics cont’d
• Believes low wages can cause too
little demand for products.
• Believes technology can worsen
working conditions for workers.
• Believes unemployment and
imperialism will occur under
capitalism.
• Believes reforms to capitalism cannot
completely fix the system.
MONETARISM
• MILTON FRIEDMAN
• MV=PQ; VELOCITY IS STABLE
• ECONOMY IS STABLE IN LR AT
NATURAL RATE OF EMPLOYMENT
• FISCAL POLICY HAS NO AFFECT
• INSTABILITY OF ECONOMY IS CAUSED
BY INCORRECT MP
Real Business Cycle Theory
• Focus on aggregate supply
• Business cycle caused by supply
factors like productivity
• Decline in GDP means less demand
for money-----supply of money
decreases
– AD falls
– Price is the same because AS also fell
COORDINATION FAILURES
• Instability occurs because “people do
not reach a mutually beneficial
equilibrium”
• Don’t coordinate their actions
• Firms and households have a
“disconnect”
• Expectations different?
RATIONAL EXPECTIONS
• ROBERT LUCAS
• PRICES ADJUST INSTANTLY
• PEOPLE ACT IN RESPONSE TO
EXPECTATIONS
• RECESSIONS SELF CORRECTING
• INFLATION IS ALWAYS ANTICIPATED
• Self correction
• Lower prices don’t change real
output even in the SR
RULES OR DISCRETION
• POLICY RULES—REDUCE INSTABILITY
– MONETARY RULE—EXPAND MONEY
SUPPLY EACH YEAR AT THE SAME
ANNUAL GROWTH RATE OF GDP
– PROMOTE STEADY GROWTH
– CONSTITUTIONAL AMENDMENT FOR A
BALANCED BUDGET?
PROS OF DISCRETION
• VELOCITY OF MONEY TOO UNSTABLE--MP CAN HELP CHANGE AD IN SR
• BALANCED BUDGET AMENDMENT
WOULD MAKE RECESSION WORSE BY
FORCING TAXES TO INCREASE AND
GOV’T SPENDING TO DECREASE
EFFICIENCY WAGE THEORY
• IF HAVE A HIGH TURNOVER OF LABOR
OR HIGH COST OF SUPERVISION,
THEN MARKET WAGE NOT EFFICIENCY
WAGE
– 1-GREATER WORK EFFORT
– 2-DECREASED SUPERVISION COST
– 3-DECREASED TURNOVER
**add to inflexibility of the wages
INSIDER-OUTSIDER PROBLEM
• DURING A RECESSION
– INSIDER—HAS JOB
– OUTSIDER—LAID OFF
• UNDERBIDING OF EXISTING WAGES TO GET
JOB BACK
• WAGES INFLEXIBLE DOWNWARD WHEN
AGGR. DEMAND DECLINES