MIT14_02F09_lec14_15 - Classical Classical vs Keynesian Theory To sum up What is an Equilibrium SHORT RUN EQUILIBRIUM AD = SRAS and IS = LM The Labor

MIT14_02F09_lec14_15 - Classical Classical vs Keynesian...

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Classical Classical vs vs Keynesian Theory Keynesian Theory
To sum up: What is an Equilibrium? 2
Classical Theory
Real Business Cycle (RBC) Wh t ll d i th b i l ? What really drives the business cycle? Kydland and Prescott developed the RBC theory that argues that real shocks to the economy are the primary cause of business cycle real shocks to the economy are the primary cause of business cycle. Real shocks are shocks that affect the production function, the size of the labor force the spending and savings decisions Nominal shocks the labor force, the spending and savings decisions,…Nominal shocks are shocks to money supply or demand In particular the RBC theory refer to productivity shocks In particular the RBC theory refer to The RBC theory is consistent with our IS-LM and AD-AS models. A negative productivity shock (A decreases) has two effects: 1) reduces MPN and hence the demand for labor and N* 2) Decreases Y* directly 4 Both effects make Y* to decrease (LRAS) and hence LM has to adjust!