Transcript Classical versus Keynesian Economics

Macroeconomic Theories
Classical vs. Keynesian Economics
Reading
• Read Keynesian Handout
CLASSICAL Economists
Classical economists were the 1st school of economic thought starting in 1776
Adam Smith was the founder and they believed:
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Markets are naturally self regulating
No government intervention necessary
Recessions are temporary
Great Depression challenged Classical View
KEYNESIAN VIEW
1. Economy is inherently unstable
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not self regulating
2. Recessions can be long & permanent
3. Major government intervention necessary
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Became popular after Great Depression (think FDR)
4. Support welfare and government assistance
5. Stagflation challenged Keynesian view
John Keynes: Founder of Keynesian Economics
1883-1946
Economic Schools of Thought
Classical Economics
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1800
1929
Keynesian Economics
|----------------------------|
1936
1979
NeoClassical Economics
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1980
2008
Housing
Bubble
Great
Depression?
Prices were
not flexible!
What Now?
Now What?
Keynesian Economics
did not help here!
How to Fix U.S. Economy?
USA Economy
LRAS1
Price
Level
E1
--------
P1 ---------
Y1
AD1
Real
GDP
SRAS1
Let Prices & Wages Adjust?
(60 minutes video: Buy American)
• Free Trade
• Protectionist => policies to reduce trade
Keynesian vs. Classicial
AS/AD Model
“Keynesian Gov’t Intervention
LRAS1
Price
Level
Y1
AD2
AD1
LRAS1
Price
Level
P1 --------- E1
Real
GDP
--------
--------
P1 --------- E1
SRAS1
AS/AD Model
“Classical Self Regulation”
Y1
End Result: Same Real GDP & Employment
Keynesian leads to more debt & higher price level
AD1
Real
GDP
SRAS1
SRAS2
End Day 1
Theory – Period Challenged
Classical Theory -
Great Depression (1929)
Keynesian Economics- Stagflation (late 1970’s)
Neo-Classical Theory Great Recession (2008)
Review:
Classical vs. Keynesian
Economy is too slow =>
GDP
“Do Nothing=> let prices adjust”
or
Help now! => use expansionary Fiscal Policy
Keynesian vs. Classical
• Keynesian economists felt recessions could be long/permanent
– More AD was needed to “fix” economy => so cut taxes & ↑ Gov’t Spending
• Classical economists felt recessions would “self regulate” because
prices would fall which would lead to more jobs
– SRAS shifts right whenever prices adjust lower
Worksheet #2
Keynesian vs. Classicial
“Keynesian Gov’t Intervention
LRAS1
Price
Level
Y1
AD2
AD1
Y2
Real
GDP
LRAS1
Price
Level
P1 --------- E1
--------
--------
P2 -------------- E2
P1 --------- E1
SRAS1
“Classical Self Regulation”
P2 -------------- AD1
Y1
Y2
End Result: Same Real GDP & Employment
Keynesian leads to more debt & higher price level
Real
GDP
SRAS1
SRAS2
Supply & Demand Free Response
Computers
Economists often Disagree
• Are tax cuts good or bad?
• Do Large Deficits always raise interest rates?
• Will taxing “rich” people significantly lower GDP?
The answer to most economic questions is:
IT DEPENDS!