Analysis of 3 Major Economic Schools of Thought: By: Matthew Alin 10/22/2008 Period: 3 Classical, Keynesian, and Monetarism Copyright © Mathew Alin Co. Premium Edition with Interactive Buttons

Origins Marked by the publication of An Inquiry Into the Nature and Causes of the Wealth of Nations in 1776 by Adam Smith. After John Maynard Keynes published The General Theory of Employment, Interest and Money, in 1936, as a response to the Great Depression of the 1930s. Milton Friedman's 1956 restatement of the quantity theory of money. ClassicalKeynesianMonetarism Who’s Adam Smith? Who’s Adam Smith? Who’s John Maynard Keynes? Who’s John Maynard Keynes? Who’s Milton Friedman? Who’s Milton Friedman? Quantity Theory of Money Formula Quantity Theory of Money Formula Basic Beliefs Copyright © Mathew Alin Co. Comparisons and Contrasts S o u rc e s

Adam Smith ( ) “founding father of modern economics” It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest. 1.Modern free market 2.Division of labor 3.The "invisible hand" Major Ideals Return to Origins Page Copyright © Mathew Alin Co.

John Maynard Keynes ( ) 1.Spending multiplier 2.Interventionist government policy 3.Founder of macroeconomics 4.Short-run Major Ideals “In the long run we’re all dead.” Return to Origins Page Copyright © Mathew Alin Co. What’s the difference between long run and short run?

Long Run vs. Short Run Assures no fixed factors of production. A firm can enter or leave the market and the cost (and availability) of land, labor, raw materials, and capital goods will vary Certain factors are fixed because there is not enough time for them to change Costs which are fixed in the short-run have no impact on a firms decisions Return to Origins Page Copyright © Mathew Alin Co.

Milton Friedman ( ) “Government is not the solution to our problem, government is the problem.” Return to Origins Page Major Ideals 1.Opposed government regulation of all sorts 2.Theorized natural rate of unemployment 3.Political and social freedom 4.Laissez Faire 5.Supply creates demand (Reaganomics) Friedman was best known for reviving interest in the money supply as a determinant of the nominal value of output (the quantity theory of money.) Copyright © Mathew Alin Co.

Say’s Law Jean-Baptiste Say formed this law –He was a firm believer of laissez faire –He was deeply influenced by Adam Smith’s book Total demand in an economy cannot exceed or fall below total supply in that economy Restated by James Mill, “supply creates its own demand.” Return to Classical Economics Page Copyright © Mathew Alin Co.

Quantity of Money Theory MV = PT Where: –M is the amount of money in circulation –V is the velocity of circulation of that money –P is the average price level –T is the number of transactions taking place Return to Origins Page Copyright © Mathew Alin Co.

Classical Economics Real Output Depends Upon… –Say’s Law –Responsive, Flexible, Prices and Wages Stressed laissez faire and free competition Benefits are great when actions are made in self-interest (invisible hand) Labor theory of value and a theory of distribution Prices and wages adjust flexibly for equilibrium Money is neutral - It will have no effect on the real output and employment of the economy. Copyright © Mathew Alin Co. More Info Return to Origins Page More Info

Labor Theory of Value and Theory of Distribution Labor Theory of ValueTheory of Distribution The value of goods produced and sold under competitive conditions tends to be proportionate to the labor costs involved with their production Divided national product between three social classes: wages for laborers, profits for owners of capital, and rents for landlords. Any particular social class could gain a larger share of the total product only at the expense of another. These theories emphasized by David Ricardo. Who’s David Ricardo? Copyright © Mathew Alin Co.

David Ricardo Often credited with systematizing economics Invisible hand Ricardo believed that in the short run prices depended on supply and demand Demonstrated comparative advantage Showed that there is mutual benefit to trade, even trade to countries with higher overall productivity, when each country specializes in areas where it has relative productivity advantage More Info Copyright © Mathew Alin Co.

Comparative Advantage Every nation should specialize in the production of those commodities it can produce most efficiently; everything else should be imported. Return To Classical Economics Page Copyright © Mathew Alin Co.

Comparisons and Contrasts C + KC + MK + MAll 1.Governments need to pay attention to the textbook fundamentals of monetary and fiscal policy 2.In the long run, changes in the money supply are neutral 3.Rational expectations 1.Long-run aggregate supply curve is inelastic 2.supply affect only the price level 3.Laissez Faire 4.Supply creates demand 5.Money matters 6.Steady and slow money growth, at a rate equal to the average growth of real output (Y) 1.An increase in money supply contains a dual effect, partly on real output, and partly on prices 2.AD is Unstable (Investment fluctuates) 3.Prices are downwardly Inflexible, or “Sticky” 1.Sustained inflation is purely a monetary phenomenon 2.Government simply cannot know enough soon enough to fine tune successfully. 3.Use quantity of money theory 4.Governments should encourage, or at least avoid discouraging, the accumulation of capital * Note: C=Classical, K=Keynesian, M=Monetarist Copyright © Mathew Alin Co. Return to Origin Page

Keynesian Economics Importance of aggregate demand as a driving factor for output, demand creates supply Support of fiscal and monetary policy Anti-supply side –economy doesn't self-adjust to full employment It is not real but nominal wages that are set in negotiations between employers and workers –Sticky prices and wages Natural Unemployment Money isn’t neutral Investment determined by long run profit expenditures and interest rate Copyright © Mathew Alin Co. Return to Origins Page More Info Keynesian Cross

Explanation Copyright © Mathew Alin Co.

Explanation of Blue curve is aggregate expenditures or aggregate demand. It is rising because as incomes increase consumers increase demand and national output also increase. Equilibrium occurs where aggregate demand equals the total amount of national output Y. Total demand equals total supply. Return to Keynesian Economics Page Copyright © Mathew Alin Co.

Monetary Policy The process by which the government, central bank, or monetary authority of a country controls…  Supply of money – the total amount of money available in an economy at a particular point in time (currency in circulation + demand deposits)  Availability of money  Interest Rate …in order to stimulate growth and stability of the economy Either expansionary (increase aggregate supply of money) or contractionary (decrease aggregate supply of money)  Expansionary- fight unemployment in a recession by lowering interest rates  Contractionary- raise interest rates to fight inflation 3 main tools of monetary policy  Open Market Operations- (Principle Tool) purchases and sales of U.S. Treasury and federal agency securities  Discount rate-the interest rate charged to commercial banks on loans they receive from the FED  Reserve requirements- the amount of funds that a depository institution must hold in reserve against specified deposit liabilities Copyright © Mathew Alin Co. Federal Reserve

The Federal Reserve The FED is the central banking system of the United States. Who is Alan Greenspan? Purpose: To manage the nation's money supply through monetary policy to achieve: 1.maximum employment 2.stable prices 3.moderate long-term interest rates Ben Bernanke, chairman of the Board of Governors of the Federal Reserve System. Copyright © Mathew Alin Co.

Alan Greenspan 13th Chairman of the Federal Reserve In office - August 11, 1987 – January 31, 2006 Greenspan was the leading authority on American domestic economic and monetary policy Return to Keynesian Economics Page Copyright © Mathew Alin Co.

Monetarist Economics Money supply is the key to the ups and downs in the economy Slow but steady growth in the money supply Excessive expansion of the money supply is inflationary Supply creates demand -the supply of money does affect the amount of spending in an economy government action is at the root of inflation gold standard highly impractical –Gold standard is a system in which the price of the national currency as measured in units of gold bars and is kept constant by the daily buying and selling of base currency to other countries and nationals Return to Origins Page Copyright © Mathew Alin Co.

Sources 1) economicshttp:// economics 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12) =STICKY%20PRICES#stickypriceshttp:// =STICKY%20PRICES#stickyprices 13) 14) 15) Copyright © Mathew Alin Co. Return to Origins Page