Macroeconomic Theory

The Business Cycle The business cycle refers to the ups and downs in the economy Sometimes the economy grows so fast that inflation drives up prices Sometimes the economy slows down in a recession with rising unemployment

Recession and Inflation Recession is at least six months of “negative growth” in the economy, with rising unemployment and declining output Inflation is at least six months of rising general price levels Because it takes six months to know if we are in a recession or inflationary period, we say there is a recognition lag of 6 months

Classical Economics Classical Economics is based on three ideas: –Say’s Law Supply creates its own demand –Self-regulating markets laissez-faire no government interference –Equation of exchange Ms x V = P x Y Money Supply x Velocity = Price x output

The Aggregate Demand Aggregate Supply Model See graph on the board

Questioning Classical Economics Thomas Malthus and population growth Karl Marx and the evil of profit

Historic Business Cycle Series of “panics” –1819 panic – depression –1857 panic – panic –1893 panic –1901 panic –1929 Great Depression

The Great Depression The Stock Market crash of 1929 The Smoot Hawley Tariff Act Drought The Hoover Administration

A New School of Economics John Maynard Keynes The General Theory of Employment, Interest and Money

The Total Expenditure Model See graph on the board

Keynesian Economic Plans Recession: Increase government spending OR Decrease taxes Inflation: Decrease government spending OR Increase taxes

Keynesian Multipliers Government multiplier =1/(1-mpc) Tax multiplier =mpc/(1-mpc)

Keynesian Fiscal Policy 1. Identify gap (recession or inflation) and amount 2. Find mpc 3. Calculate multipliers 4. Calculate needed policy change: –Gap = Gov’t spending x multiplier –Gap = Tax change x mulitiplier

Deficits and Debt If the government spends money it doesn’t have (hasn’t collected in taxes) the government runs a deficit Add all the deficits together from 1776 until today and you have the National Debt bt_clock.htmhttp:// bt_clock.htm

The National Debt

National Debt Problems Foreign owned sector is increasing 40% of the National Debt is now held by our own government, so we’ll have to pay taxes to pay ourselves 22% of the National Debt is held by other countries and we’ll have to tax ourselves to pay those other countries

Assets and Liabilities Remember Accounting 1000? Assets and Liabilities The National Debt is a Liability Where’s the National Asset Clock? What did we buy with our National Debt?

What else (besides government) makes economies grow? Capital “Deepening” –More “capital per worker” can make those workers more productive and increase output Labor Growth –More workers Technological Progress –New ways of doing things, new inventions which are more efficient

National Budget The past administration ran up huge deficits and added trillions to the National Debt. The current administration is doing the same. Could you do better? Try your hand at balancing the Federal Budget by playing the Budget Game at

Budget Simulation After trying the Budget Simulation, describe the results of your budget. This one page essay is due on Class Session 10. Don’t print out the results of your budget changes, just summarize the changes you made.