notes7spring2018wpd.pdf - MACROECONOMICS 201(Spring 2018...

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MACROECONOMICS 201 ( (Spring 2018) NOTES 7 AGGREGATE SUPPLY AND DEMAND Reading Assignments: Principles of Economics: Chapters 24 & 26 Madariaga: 34, 64, 82, 99 Our primary purpose in notes 7 is to revisit and further analyze the aggregate demand/ aggregate/supply model that we touched upon in notes 3, 4, and 6 and describe how it can be used to help understand methods of stabilizing the economy that have been developed since 1935. Before embarking on this discussion, however, we will briefly mention several earlier great thinkers in macroeconomics and their continuing influence, including John Maynard Keynes, who developed basic economic insights that continue to this day. 1. Great Thinkers in Economics of the past: A. Adam Smith (1723-1790): We have already discussed his economic framework in notes 2. In 1776, in his seminal book, The Wealth of Nations , he developed a modern theory of a market economy which has guided most economists, as well as the current economic policies of most countries in the world. He set forth the famous principle of the invisible hand, which leads producers, if they are in a competitive situation, and each following his or her own self interest, to make decisions which result in producing only those goods and services that people most desire, by the least expensive method. I would regard Adam Smith as one of the most influential economists of all time. B. Thomas Malthus (1766-1834) : Malthus argued that population increases at a geometric rate (i.e. 2, 4, 8, 16, 32, 64, 128, etc.) whereas the food supply grows at an arithmetic rate (i.e. 1, 2, 3, 4, 5, 6, 7, 8, etc.). Basically, population would always increase faster than the food supply. In consequence, the bulk of humanity was always doomed to a subsistence existence. These ideas gained great popularity at the time and economics came to be known as “the dismal science,” a term still sometimes used to describe economics, especially by students. Population would be ultimately be limited by starvation and disease. Why hasn’t the predictions of Malthus been borne out. Many different reasons can be postulated. Among the more important are: 1. the enormous outlet for excessive populations made possible by the discovery of the Americas; 2. the enormous changes in technology leading to a rapid rise in output; 3. and more recently, reliable and widely used birth control methods. Laugh if you will, this was a widely accepted theory at the time, and used by some as a basis for a do- nothing public policy for poor people (since their number would always expand faster than output so any aid would be self-defeating), and may not have been as inaccurate as some of you may think. At the time that Malthus made these predictions, they came close to actually describing the world he lived in. Moreover, even today, in some parts of the world, perhaps mostly in Africa and the Middle-East, the Malthusian trap might still be occurring. India, at the time the British took it over, was almost as prosperous as Europe. The introduction of modern sanitation and public
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