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Unformatted text preview: INSTRUCTOR COMMENTARY Chapter Reference: Chapters 8 & 9 Survey of Macroeconomic Theory Before 1975 1. Chapters 8 and 9 focus on the following important concepts: A. The purposes of macroeconomic theory. The purposes of macroeconomic theory are to predict and explain the behavior of the overall economy, with particular emphasis on GDP, the price level, the unemployment rate and the rate of economic growth. (text, Chapter 1, p. 8) B. The essential elements of Classical macroeconomic theory. Classical macroeconomic theory was based on three premises: (1) Says Law (supply creates its own demand) would characterize a money-using market economy so long as no household saving occurred; (2) the rate of interest would adjustment to ensure that any dollars saved by households (and withdrawn from the circular flow) would be matched by an equal amount of investment expenditures by business firms (so that the saved dollars would be returned to the circular flow in the form of investment expenditures); and (3) wages and prices would exhibit downward flexibility so that any surpluses of goods (in the output market) or of labor (in the resource market) would be eliminated. (text, pp. 197-198) C. The fundamental conclusion of Classical macroeconomic theory. The fundamental conclusion of Classical macroeconomic theory was that the economy could be in equilibrium only at the full employment production level. The implication of this conclusion was that government needed to play no role in stabilizing the economy at the full employment GDP level. This would occur automatically as market forces operated to return the economy to a full employment real GDP level. (text, p. 198 D. The fundamental problem of Classical macroeconomic theory. Classical macroeconomic theory was incapable of explaining the depression of the 1930s. The economy continued its downward spiral for four years, from 1929 to 1933, and had barely recovered to pre-depression levels of economic activity by the early 1940s. 1 Between 1929 and 1933 the level of real GDP declined by nearly 50%, and the unemployment rate rose to about 25% of the labor force. . The depression continued throughout the decade of the 1930s, and only Americas preparation for and eventual entry into the Second World War ultimately caused the economy to return to high levels of production and employment. By 1944, the national unemployment rate had fallen below 3% and labor shortages, not surpluses, were the main problem. E. The essential elements of Keynesian macroeconomic theory. Keynesian theory emphasized aggregate expenditures rather than aggregate supply. He argued that the equilibrium level of GDP would be determined by the total of aggregate expenditures by households (consumption), firms (investment), government, and net exports (exports minus imports). He argued that the relationship between Consumption and Disposable Income was linear (slope defined as the MPC), and, combined with the levels of autonomous...
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This note was uploaded on 01/12/2012 for the course ECN 211 taught by Professor Kingston during the Spring '08 term at ASU.
- Spring '08