Macroeconomic Theories Classical vs. Keynesian Economics

Reading Read Keynesian Handout

CLASSICAL Economists Markets are naturally self regulating Classical economists were the 1st school of economic thought starting in 1776 Adam Smith was the founder and they believed: Markets are naturally self regulating No government intervention necessary Recessions are temporary Great Depression challenged Classical View

KEYNESIAN VIEW Economy is inherently unstable not self regulating Recessions can be long & permanent Major government intervention necessary Became popular after Great Depression (think FDR) Support welfare and government assistance Stagflation challenged Keynesian view John Keynes: Founder of Keynesian Economics 1883-1946

Economic Schools of Thought NeoClassical Economics |--------------------------------| Classical Economics |----------------------------| Keynesian Economics |----------------------------| 1800 1929 1980 2008 1936 1979 Great Depression? Prices were not flexible! What Now? Housing Bubble Now What? Keynesian Economics did not help here!

How to Fix U.S. Economy? USA Economy --------- -------- Price Level P1 LRAS1 Price Level Real GDP SRAS1 AD1 -------- --------- P1 Y1 E1

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 AS/AD Model “Classical Self Regulation” LRAS1 Price Level Real GDP SRAS1 LRAS1 Price Level Real GDP SRAS1 SRAS2 AD1 AD1 -------- --------- P1 Y1 E1 AD2 -------- --------- P1 Y1 E1 End Result: Same Real GDP & Employment Keynesian leads to more debt & higher price level

End Day 1

Theory – Period Challenged Classical Theory - Great Depression (1929) Keynesian Economics- Stagflation (late 1970’s) Neo-Classical Theory Great Recession (2008)

Economy is too slow => Review: Classical vs. Keynesian “Do Nothing=> let prices adjust” or Economy is too slow => 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 “Classical Self Regulation” LRAS1 Price Level Real GDP SRAS1 LRAS1 Price Level Real GDP SRAS1 SRAS2 AD1 AD1 P2 -------------- E2 -------- --------- P1 Y1 E1 AD2 -------- --------- P1 Y1 E1 P2 -------------- Y2 Y2 End Result: Same Real GDP & Employment Keynesian leads to more debt & higher price level

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!