1. Macroeconomic Theories
Classical & Keynesian
versus
New Classical & Supply Side

2. CLASSICAL VIEW Markets are naturally self regulating
No government intervention necessary
Recessions are temporary
Wages & prices are flexible
Savings = Investment
Says law: Supply will create its own demand
Against: minimum wages, welfare & Gov’t assistance
Great Depression challenged Classical View

3. Aggregate Supply and Aggregate Demand in Classical Economics
9-2b
Classical View
FIGURE 9-1
Aggregate Supply and Aggregate Demand in Classical Economics

4. KEYNSIAN VIEW Economy is inherently unstable & not self adjusting
Recessions are long & often permanent
Major government intervention necessary to stimulate AD
Wages & prices are sticky or fixed
Support welfare & Gov’t assistance
Lack of consumer demand caused great depression
AS curve is very flat or horizontal
Interest rates changes are not effective during recession
Money Demand not very sensitive to interest rates

5. Keynesian View

6. Macroeconomic Debates
Two major schools decidedly against government intervention have developed:
Monetarism & New Classical Economics

7. Monetarism Main message: money matters & the economy self-regulates
Monetarism believes in the Quantity Theory of Money
MV = PQ, Inflation is purely a monetary phenomena
Generally do not advocate activist monetary policy stabilization:
expanding money supply during bad times and slowing during good
Focus on price stability
Theory not compatible with upward sloping AS curve
GDP is an imperfect measure of transactions to use in calculating velocity because it does not include transactions in intermediate goods or in existing assets, some of which are made using money and do influence the number of times money changes hands during a year.

8. New Classical Attempted to explain stagflation of 1970’s
Business Cycles happen, but recessions are temporary
AS could be broken down into Short-run & Long run curves
Government intervention is unnecessary
Prices/wages are flexible in long run, sticky in short-run
People make decisions on rational expectations
This explains “shocks” to the system

9. Aggregate Supply in the New Classical Model
Both models can be used as a “New Classical Model”
FIGURE 9-5
Aggregate Supply in the New Classical Model
SRAS LR

10. Supply-Side Policy Government Incentives Matter
Goal: use incentives to shift the aggregate supply curve right
The supply-side toolbox consists of:
Tax cuts to stimulate work effort, saving, and investment
Deregulation to reduce production cost/stimulate investment.
Expenditures on education training/research expands capacity to produce
Immigration policies alter the size/skill of labor force

11. 9-4
Summary
No theory is designed to explain all the complex relationships of a macroeconomy
There is no simple relationships that can be easily manipulated to neatly solve various problems as they arise.
Assessing economic theories would be easier if we lived in closed economies.