THEORIES

Adam Smith 1776 – Wealth of Nations Classical Theory Adam Smith 1776 – Wealth of Nations The wealth of a nation depends on its ability to produce (which depends on the quantity and quality of its land, labor and capital) A Long Run theory Pro-capitalism Free markets generate full employment (in the long run) Government’s role should be limited Say’s Law – “Supply creates its own demand” Supply matters more than demand “… he [a businessman] intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.” Adam Smith

Karl Marx Das Kapital (1867 – 1894) Communism Karl Marx Das Kapital (1867 – 1894) Capitalism is based on the exploitation of labor and is doomed to destruction, probably by a workers’ revolution. Private individuals should not be allowed to own land or capital. These should be owned by “the state” for the common good. “Workers of the world unite. You have nothing to lose but your chains.” “From each according to his ability; to each according to his need.” Karl Marx

Keynesian Theory John Maynard Keynes The General Theory of Employment, Interest & Money (1936) A Short Run theory Unemployment is a problem in the short run Inflation is not a problem The government has a role to play in creating full employment Demand matters more than supply (“Demand creates its own supply”) Government spending can/should be used to create the “right” amount of aggregate demand. Printing money is not very effective at changing demand. “In the long run we are all dead.” JM Keynes

Milton Friedman A Monetary History of the United States (1963) Monetarist Theory Milton Friedman A Monetary History of the United States (1963) Greater emphasis back to the Long Run* Inflation is a problem. Markets will create “full employment.”* Government’s role should be limited – policies often do more harm than good.* The money supply is the primary determinant of Aggregate Demand and changes of spending mainly affect inflation. “Inflation is everywhere and always a monetary phenomenon.” Milton Friedman *These sound like classical theory

For our purposes we will consider two theories: Classical/monetarist theory (CMT) and Keynesian theory (KT) ISSUE CMT KT Time horizon long short Markets work … well poorly Unemployment is low high Gov’t should do… as little as possible what is needed real growth is caused by … Investment – more capital - Supply more Spending -- Demand MD (CASH) does not change changes Velocity of Money (v)