Chapter 11

Chapter 11 - Chapter 11 Keynesian Foundations of Modern...

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Chapter 11 - Keynesian Foundations of Modern Macroeconomics NOTE: In this chapter we will NOT cover the section titled "Keynesian Model of Spending and Output" starting on page 250 and ending on the top of page 256 and we will not cover the section "The Multiplier" starting on page 258 to the top of page 262. The foundations of the field of microeconomics ("price theory") were largely established in the 1800s and have not changed or evolved much, since economic laws (supply and demand) are basically irrefutable, mechanical descriptions of the economic universe, similar to the laws that describe the physical universe (law of gravity, law of thermodynamics, etc). However, the field of macroeconomics IS evolving and changing all the time, as we learn more about the business cycle, economic fluctuations, the role of expectations, the effects of fiscal and monetary policy on the economy, etc. Economics is a "social science" and therefore economics looks at how people act in the economy. Once we allow the complexities of human behavior (emotions, self-interest, greed, etc) to affect economic outcomes in the macroeconomy, it makes macroeconomic analysis extremely complex, and theories evolve over time to explain the macroeconomy. From the time of Adam Smith (1776) until the Great Depression of the 1930s, almost all economists were Classical economists - they believed that the self-correcting mechanisms of a market economy would continually guide the economy toward full output/full employment. Market prices would adjust to restore the economy to full employment. For example, in a recession or econ contraction, wages, prices and interest rates would fall and would eventually stimulate the economy back to full output. There was little role for government in the classical model and in practice - Fed spending was only 3% of national income. During the 1930s we experienced the Great Depression, the stock market crash, bank failures, a decade of unemployment averaging about 20% (high of 25% in 1933, see page 351). Great Depression was a worldwide phenomenon. Debate: Did the self-correcting mechanism of the market economy fail? or Did the fiscal and monetary policies of Congress and the FRS fail? Congress raised taxes and imposed tariffs (taxes) during a recession, and the FRS contracted the MS by 1/3 - Great Contraction. Debate continues: Activist, discretionary policy (Keynesian "fine-tuning") vs. Non- activist, Passive policy (Classical). Traditional, Keynesian approach - Activist approach for policy. Government (fiscal policy) and Federal Reserve (monetary policy) should play an active role in attempting to stabilize the economy by "fine- tuning." Discretionary approach to fine- tuning. Figure out what's wrong and try to fix it. Counter-cyclical approach.
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This note was uploaded on 11/18/2011 for the course ECON 103 taught by Professor Lin during the Spring '08 term at Rutgers.

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Chapter 11 - Chapter 11 Keynesian Foundations of Modern...

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