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46 Cards in this Set

  • Front
  • Back
• Keynesian Economics
opposing or complimentary to a market-oriented economy
o Keynesian View of recession
• Aggregate Demand is not high enough for firms to reach full employment
• Macro economy may adjust slowly to shifts in aggregate demand because of stickiness of wage prices
o Aggregate Demand
total demand for goods in an economy
o Coordination argument
decline in own wage – OK – if everyone experiences it
• Market Oriented Economy – no way to do this
o Menu Costs
costs that firms face when changing prices
• Two Keynesian Assumptions (AS-AD model)
o Importance of AD in causing recession
o Stickiness of wages/prices
o Permanent Income Hypothesis
when individuals think about how much to consume and consider how much income they will make in their lifetime
When to save or borrow
low interest rate borrow
high interest rate save
o Expected rate of return based on
• Investment opportunities
• Future economy
• New technology
• What causes consumption to shift
future incomes
whether to save or borrow
• What causes government demand to shift
o Make decisions based on politics
o Levels of GDP
• reason why AD shifts to left
o Consumption – rise in tax, income, interest rate, savings, fall in wealth and expected income
o Investment – rise in interest rate, decrease in rate of return and business confidence
o Government – fall in spending
o Export/Import – rise in price of US goods, fall in foreign demand
• Phillips Curve
o Price wages are sticky and do not adjust rapidly according to Keynesian
o During each economic recession, real GDP is below potential GDP and high unemployment – pressures for inflationary increases in price level also tend to be low
o High inflation when unemployment is low
o Stagflation
when an economy experiences stagnant growth and inflation at same time – unhealthy
Keynesian solution to recession
use tax cuts and policies to shift AD to the right
stimulate consumption and investments
increase government spending
When unemployment is low and inflation is high
increase taxes
decrease in government spending
o Pay off
allows closer analysis on how shifts in demand/spending affect the rest of the economy
o Expenditure output model
macroeconomic model in which equilibrium output occurs where the total or aggregate expenditures in the economy are equal to the amount produced; “Keynesian Cross Model”
o National incomes
sum of all income received for producing GDP
o Aggregate expenditure schedule
total expenditure in economy for each level of real GDP
o MPC – Marginal Propensity to Consume
share of an additional dollar of income that goes to consumption

• MPC + MPS = 1
o MPS – Marginal Propensity to Save
share of additional dollar that goes to saving
• MPC + MPS = 1
o Consumption function
relationship between income and expenditures on consumption
o Shift in consumption function
• Up – tax cut so consumer spends more
• Down – tax raise so consumer spends less
• Investment as a function of National Income
o Investment decisions – forward – looking based on Rate of Return
o Doesn’t change with current national income
• Combined Aggregate Expenditure Function
o AE line = C+I+G+X-M
o Equilibrium – NI=AE
o Recessionary gap
gap in output between an economy in recession and a potential GDP
o Inflationary gap
when an economy has output above potential GDP the cap from that level of output to potential GDP
o Multiplier Effect
how a given change in expenditure cycles repeatedly through the economy, and thus, has a larger final impact than the initial change
o Multiplier
total increase in AE % original increase
• Calculating Multiplier
o Fraction of expenditures recycled (f)-
f=1-whatgoesintotaxes – whatgoesintosavings – whatgoesintoimports
o Multiplier affects government spending and any economic change
• Multiplier Trade Off
o Higher multiplier – more unstable economy
o Lower multiplier – more stable economy
• The Neoclassical perspective
emphasizes that the economy seems to rebound in the long run to its potential GDP and natural state of unemployment
wages/prices will adjust in a flexible manner
o Long run neoclassical model
as economic output rises above potential GDP, level of unemployment falls
o High demand for labor drives up wages
o Rise of wages = upward shift in short-run Keynesian aggregate supply curve
o During unemployment
• Can old on pay increases
• Can replace high pay workers with those willing to work for lower prices
o Rational Expectations - and at macro level
the theory that people form the most accurate possible expectations about the future that they can using all the information available to them

• At macro level – theory of rational expectations – If AS curve is vertical over time people should expect this pattern
o Adaptive expectations
the theory that people look at past experiences and gradually adapt their beliefs and behavior as circumstances change
• Policy implications of the Neoclassical Perspective
o The economy has a self-correcting tendency to move back to potential GDP
o Encouraging long-term growth – more important fighting recession
skeptics of neoclassical economists
skeptical of the governments ability to manipulate aggregate demand skillfully and in a timely manner – focus attention on long run productivity growth – economy’s investments in human capital, physical capital and technology operating together in a market-oriented environment that rewards innovation
o 2 categories of unemployment
• Cyclical
economy producing below potential GDP – less incentive to hire (caused by recession
employment rate created by the forces of supply and demand in the labor market, even when the economy is at its potential GDP
Rise in neoclassical AD
leads to inflationary pressures
• Neoclassical Phillips curve trade off
o Long run as curve – vertical
o Unemployment rate is the natural rate
o Milton Freidman – “There is always a temporary trade off between inflation and unemployment; no permanent trade off.”
o Keynesian Perspective – focus on getting level of AD right in relationship to an upward sloping aggregate supply curve – AD should be adjusted so that the economy produces at its potential GDP, not so that cyclical unemployment results and not so high that inflation results
• Says Law
supply creates demand
• Keynes Law
demand creates its own supply