Module 35 May 2015

 According to the classical model of the price level, the aggregate supply curve is vertical even in the short run.  Business cycle – American economist Wesley Mitchell pioneered the quantitative study of business cycles. His work allowed for the accurate measurement of business cycles, but not theory of business cycles.

 John Maynard Keynes – The General Theory of Employment, Interest, and Money.  Adam Smith – Wealth of Nations  Keynes economics reflect 2 main ideas – the short-run effects of shifts in aggregate demand on aggregate output, rather than long-run determination of the aggregate price level

 Classical vs. Keynesian  One important difference between classical and Keynesian economics involves the short-run aggregate supply curve. Panel (a) shows the classical view; where the SRAS is vertical…shifts in the aggregate demand affect the aggregate price level but not the aggregate output.  (b) shows the Keynesian view, the short run SRAS curve slopes upward, so shift in the aggregate demand affect aggregate output as well as aggregate price

Figure 35.1 Classical Versus Keynesian Macroeconomics Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

 The second important factor is that classical economists emphasized the role of changes in the money supply in shifting the aggregate demand curve, paying little attention to other factors. Keynes argued that other factors, especially changes in animal spirits (business confidence) are mainly responsible for business cycles.  Before Keynes, economists argued that a decline in business confidence would have not effect on agg PL or agg output…Keynes proved otherwise

 Macroeconomic policy activism – the use of monetary and fiscal policy to smooth out the business cycle. Keyne’s general theory was that monetary policy would not be effective during a recession Fiscal policy involves gov spending/tax rates and decisions made about it are political; monetary policy is free from politics Most feel that if the central bank was quicker to react, we would not have experienced such a bad depression

 Natural rate hypothesis – to avoid accelerating inflation over time, the unemployment rate must be high enough that the actual inflation rate equals the expected inflation rate  Political business cycle – results when politicians use macroeconomic policy to serve political ends

 New classical macroeconomics – is an approach to the business cycle that returns to the classical view that shifts in the aggregate demand curve affect only the aggregate price level, not aggregate output  Rational expectations – the view that individuals and firms make decisions optimally, using all available information  New Keynesian economics – market imperfections can lead to price stickiness for the economy as a whole.  Real business cycle theory – claims that fluctuations in the rate of growth of total factor productivity cause the business cycle