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Chapter8Summary

Chapter8Summary - Chapter 8 Summary Tucker Macroeconomics...

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Chapter 8 Summary Tucker , Macroeconomics for Today , 5th Edn. 1. The Classical School of macroeconomic theory began with Adam Smith in 1776 (Inquiry into the Nature and Causes of the Wealth of Nations ) and continued through the early part of the twentieth century (up to the great depression of the 1930s). The basic conclusion of this school was that the macro economy could be in equilibrium only at full employment output levels. The most important public policy implication of this theory is that government should do nothing to counteract a recession or depression, because market forces would automatically return the economy to its full employment (equilibrium) level of output. 2. This Classical conclusion was based on: (a) Say's Law; (b) the role of the interest rate to equilibrate saving and investment; and (c) wage and price flexibility. Say's law states that "supply creates its own demand." It is true, by definition, in a barter economy. It also is true in a money-using economy with no saving. Think about the identity of the flow of product (upper loop) of the circular flow graph, and the flow of payments to resources owners (lower loop). But, the Classical writers went even further, and argued that Say's Law would hold in a money-using economy in which household saving occurred. This would occur because households were expected to save more (out of a full employment level of GDP) when interest rates were high, and save less when interest rates were low (that is, household saving was positively related to the market rate of interest, all other things equal). This positively sloped supply schedule of savings intersected a negatively sloped investment demand function which was based on the assumption of an inverse (or negative) relationship between planned investment expenditures and the rate of interest. Higher rates of interest were expected to reduce the present values of the profits expected to flow in over time
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