CHAPTER 9 Classical Macroeconomics and the Self-Regulating Economy This chapter uses the aggregate demand-aggregate supply model developed in Chapter 8 to describe the three possible states of an economy (recessionary gap, inflationary gap, and long- run equilibrium), and analyzes the concept of the self-regulating economy, developed by the classical economists and advocated by some modern economists. KEY IDEAS 1.Although classical economists lived and wrote many years ago, their ideas are often employed by some modern economists. 2.There are three possible states of an economy. 3.The concept of a self-regulating economy was developed by the classical economists and is advocated by some modern economists. 4.Business-cycle and economic-growth macroeconomics compose two categories of macroeconomics. CHAPTER OUTLINE I.THE CLASSICAL VIEW Although classical economists lived and wrote many years ago, their ideas are often employed by some modern economists. A.Classical Economists and Say’s Law Classical economists believed that there could never be a general surplus of goods and services in the economy because they believed in Say’s law. Say’s law says that production creates demand sufficient to purchase all goods and services produced. If Say’s law is valid, then people will spend enough to buy all of the goods and services produced. Even if people will save part of their income, interest rate flexibility will insure that the money saved by consumers will be spent on investment goods by firms. B.Classical Economists and Interest Rate Flexibility According to classical economists, Say’s law holds both in a barter economy and in a money economy since interest rates will adjust to equate saving and investment. Therefore, any fall in consumption (and consequent rise in saving) will be matched by an equal rise in investment.
