Transcript Economic Instability: A Critique Of The Self Regulating Economy

Economic Instability: A Critique
Of The Self Regulating Economy
Questioning The Classical Position
 Keynes and Keynesian thought the classical
view of the economy was wrong.
Questioning The Classical Position
(continued)
 The classical:
1. Say’s law holds
insufficient demand in the economy is
unlikely.
2. Wages, prices, and interest rates are flexible.
3. The economy is self regulating.
Keynes’s Criticism Of Say’s Law In A
Money Economy
 Classical economists:
- If consumption spending fell because
saving increased, then
total spending would not fall because the
added saving brings more investment
spending,
(Keynes disagreed)
Keynes’s Criticism Of Say’s Law In A
Money Economy (continued)
 Keynes’s view of Say’s law in a money
economy:
a decrease in “consumption” and
subsequent increase in “saving” may not be
matched by an equal increase in
“investment.” Thus a decrease in “total
expenditures” may occur.
Exhibit 1 Page 197.
Keynes’s Criticism Of Say’s Law In A
Money Economy (continued)
 Classical:
“saving” and “investment” depend on the
interest rate.
Keynes:
“saving” and “investment” depend on a
number of factors that may be far more
influential than the interest rate.
Keynes On Wage Rates
 Classical:
if unemployment rate is greater than the natural
unemployment rate, a surplus exists in the labor
market (Table Page 184), thus wage rate fall.
Keynes:
did not believe above statement adjusted so
simple. Wage rates may be inflexible in a
downward direction.
Exhibit 2 Page 199
New Keynesians And Wage Rates
 Efficiency wage models:
sometimes in the best interest of business
firms to pay their employee higher than
equilibrium wage rates.
Keynes On Prices
 Classical:
prices in the economy are flexible, move up
and down in response to market forces.
Keynes:
not always competitive enough to allow
prices to fall.
 Exhibit 3 Page 200
How long it takes for wage rates and prices
to fall.
The Simple Keynesian Model
 Assumptions:
1. The price level is constant until economy
reaches its full employment (Natural Real
GDP).
2. No foreign sector (closed economy)
TE = C + I + G
3. Monetary side of the economy is
excluded.
The Simple Keynesian Model
(continued)
 The consumption function:
1. “Consumption” depends on “disposable income”.
“Disposable income” = income – taxes
2. Consumption and disposable income move in the same direction.
3. When disposable income changes, consumption changes by less.
C = Co + (MPC)(Yd)
MPC = marginal propensity to consume
MPC = delta C / delta Yd
Co = autonomous consumption, independent of disposable income.
The Simple Keynesian Model
(continued)
 Consumption and saving:
S = Yd – [Co + (MPC)(Yd)]
MPS = delta S / delta Yd
MPC + MPS = 1
The Simple Keynesian Model
(continued)
 Multiplier:
- to obtain the overall change in total
spending.
m = 1 / ( 1 – MPC )
Change in total spending = multiplier x
change in autonomous spending
The Simple Keynesian Model In The
AD-AS Framework
 Shifts in the Aggregate Demand Curve:
- There are C, I, G that can shift the AD
curve.
- Co increases…..C increases……………
AD increases
Exhibit 5 Page 207.
The Simple Keynesian Model In The
AD-AS Framework (continued)
 The Keynesian Aggregate Supply Curve:
- has both a horizontal section and a vertical
section.
Exhibit 6 Page 207.
The Simple Keynesian Model In The
AD-AS Framework (continued)
 The economy in a recessionary gap:
- Keynes believed the economy could get
stuck in a recessionary gap.
Exhibit 7 Page 209.
The Simple Keynesian Model In The TE (Total
Expenditure) – TP (Total Product)
 Deriving a Total Expenditure (TE) curve:
TE = C + I + G
Exhibit 8 Page 211.
TE curve is upward sloping.
The Simple Keynesian Model In The TE (Total
Expenditure) – TP (Total Product) (continued)
 What will shift the TE curve?:
- TE curve shifts if there is change in C, I, or
G.
- a rise in C will shift the TE curve upward.
- a decline in I will shift the TE.
The Simple Keynesian Model In The TE (Total
Expenditure) – TP (Total Product) (continued)
 Comparing Total Expenditure (TE) and Total
Production (TP):
1. TE < TP, disequilibrium
2. TE > TP, disequilibrium
3. TE = TP, equilibrium