1. THEORIES

2. Adam Smith 1776 – Wealth of Nations
Classical Theory
Adam Smith – 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

3. 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

4. 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

5. 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

6. 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)