Lecture Notes Days 5- 6. Flaws in Classical Model and Keynsian Model

Lecture Notes Days 5- 6. Flaws in Classical Model and Keynsian Model

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Day 5: Classical Versus Keynesian Model Classical Model: Adam Smith, David Ricardo, John Stuart Mill… Capitalist economy generates its own auto-pilot: disturbances set up the conditions of their own recovery, as all the markets work together. Calls for a Laissez-faire policy. Ex: Not enough saving? Price of capital (interest rate) increases and more people save Ex: too much stuff? Prices fall, consumption increases Ex: Unemployment? Wages fall until employers would hire more people, fewer people want to work Whoops: Great Depression: Prices fell, inventories increased (gluts) Wages fell, unemployment increased Aspects of the Classical Model: Quantity Theory of Money: MV = PQ M = money stock in economy V = income velocity of money (turnover) P = price level Q = level of real national income (real GDP) True by definition Argued that V and Q are determined by external institutional factors; thus are constant: _ _ MV = PQ Thus, increasing M simply leads to increases in P – inflation! Changing Money (monetary policy) can’t expand economy…only production, and the labor market, can The goods and labor markets Equilibrium determined by the demand and supply of labor. Increase in the demand for labor increase output. Wages determine who will work and labor supply = labor demand…full employment. If you won’t work at the given wage, you are not unemployed. If wages are flexile, no unemployment. Leads to equilibrium in goods. Equilibrium: A state of balance in which there are no internal pressures for change. A market is in equilibrium when quantity demanded = quantity supplied; prices make the adjustments. Price Quantity Equilibrium Price Demand Supply
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Say’s Law French Economist John Baptiste Say “supply creates it’s own demand” In the process of production, firms pay workers, suppliers etc…for every dollar of product produced, a
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This note was uploaded on 04/04/2012 for the course ECON 104 taught by Professor Dolenc during the Spring '08 term at UMass (Amherst).

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Lecture Notes Days 5- 6. Flaws in Classical Model and Keynsian Model

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