PP_Slides_Class_16_Monday_March_17

PP_Slides_Class_16_Monday_March_17 - Good Afternoon Class...

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Good Afternoon!! Class 16 Monday, March 17
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Keynes’ Critique of classical economics Economy can be at equilibrium which is not full employment Why?
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1. I ≠ S -at low interest rates, firms with unused capacity don’t invest because investment would not be profitable 1. Wages and prices not flexible downwards -labor unions seldom cut wages -highly concentrated industries seldom cut prices
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Classical -recession is temporary because economy is self correcting -declining investment is pushed up by falling interest rates -declining consumption is pushed up by falling prices and wages -government is to stand back and do nothing
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Keynes -recession is not necessarily temporary because the self-correcting mechanisms of falling interest rates and falling wages and prices might not be enough to get economy back to full employment -government must do something
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What causes recessions in the Keynesian model? -decline in profit expectations Investment is the most volatile component of GDP
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Keynesian Long Run Aggregate Supply Curve
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Flat -lots of excess capacity -output expands and prices don’t rise Curve -little excess capacity -output expands and prices rise Vertical -at capacity -output doesn’t expand but prices rise
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Capacity Utilization Rate in Manufacturing 85% is full employment
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The Keynesian and Classical aggregate supply analyses are virtually identical. But they are completely at odds with respect to aggregate demand. Keynes focused on aggregate demand.
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For Keynes, economy can have equilibrium -low level of aggregate demand get unemployment -full employment level of aggregate demand -excessive aggregate demand get inflation Inherent tradeoff: can’t have unemployment and inflation at same time
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Three Aggregate Demand Curves
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PP_Slides_Class_16_Monday_March_17 - Good Afternoon Class...

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