ECON 1110 Lecture Notes 04

ECON 1110 Lecture Notes 04 - ECON 1110 Lecture Notes 4 ECON...

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ECON 1110 Lecture Notes 4 ECON 1110 Intermediate Macroeconomics James R. Maloy Spring 2011 Lecture Notes for Topic 4: Keynesian Macroeconomics (I) Readings: Froyen Ch. 5 (8 th Ed. Ch. 6) I. The Foundations of the Keynesian Revolution The Great Depression of the 1930’s and the enormous long-term persistency of high unemployment and low output could not be explained by the classical model. In the classical framework, recessions were possible but were expected to be of relatively short duration and would correct themselves. A depression that lasted for years with no sign of recovery was unfathomable. About the only remedy Marshall and other economists could come up with to solve the problem was to educate people better so they would make better decisions. According to the classical model, output was entirely determined by supply factors, and no change in aggregate demand, and no government policy, could be effectively used to alleviate the problems. Indeed, many of the policies undertaken at the time, such as tax and tariff increases, were exactly opposite of those we typically expect to see from government policy in a recession. For example, governments at the time faced falling tax revenues due to the high level of unemployment. To close the resulting budget deficit, governments raised taxes. Under the classical analysis, such tax increases should not affect the economy, but in reality caused great harm. Indeed, it is generally agreed that governmental mistakes greatly lengthened the Depression. A group of economists, led by John Maynard Keynes, challenged the classical orthodoxy and suggested a necessary and positive role for government. Keynes developed a radical new way of looking at the problem. He argued that aggregate demand, not aggregate supply, was the factor that determined output. He asserted that the Depression was the result of aggregate demand being too low, and furthermore asserted that government policy was indeed effective in changing aggregate demand. He and his followers produced a model that made aggregate demand the major determinant of output, and argued that aggregate demand was not stable and required government intervention to stabilise it. 1
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ECON 1110 Lecture Notes 4 It is interesting to note Keynes' rationale for his new model. As one observer of economic thought put it: "The liberal capitalism of the modern age, which Smith had heralded, whose victory Ricardo had proclaimed, and which Marx sought to destroy, was transformed by Keynes and given a new life." 1 During the apparent collapse of capitalism during the 1930's and greater adherence to communist and fascist ideology (although there is some debate about what Keynes actually thought of fascist economics), Keynes decided that his task was to save capitalism--although some opponents of Keynes argue that his system actually destroys it. He commented, "How can I adopt a creed [communism] which, preferring the mud to the fish, exalts the boorish proletariat above the bourgeois and the
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This note was uploaded on 03/10/2012 for the course ECON 1110 taught by Professor Tedloch-temzelides during the Spring '08 term at Pittsburgh.

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ECON 1110 Lecture Notes 04 - ECON 1110 Lecture Notes 4 ECON...

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