Classical vs. Keynsian Models Notes

Classical vs. Keynsian Models Notes - Sheila Walsh Chapter...

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Sheila Walsh Chapter 8 Notes 2009 American Recovery and Reinvestment Act of 2009 increased gov’t spending and cut taxes by combined total of $787 billion to help economy recover from recession. Required gov’t to borrow hundreds of billions of additional dollars over next couple years Some argued it wouldn’t help economy, others said it would improve it Macroeconomic Models: Classic versus Keynesian - Over periods of several years or longer, economy performs rather well - Until Great Depression, little reason to question these ideas b/c there was not drastic deviation from potential, full-employment level - By 1960s, Macroeconomics was Keynesian economics Why Classical Model is Important 1. Over last several decades, there has been active counterrevolution against Keynes’s approach to macro. New theories largely based on classical ideas. 2. **It is more useful model in explaining long- run trend. Kenyes’s ideas and their development help us understand economic fluctuations- movements in output around its long-run trend Assumptions of the Classical Model - Many assumptions are simplifying - Typically involve aggregation - combine many different interest rates in economy and refer to single interest rate - combine types of labor into aggregate labor market ** A critical assumption in classical model is that markets clear : The price in every market will adjust until quantity supplied and quantity demanded are equal. - idea that eventually, excess supply will drive price up and excess demand will drive price down
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Sheila Walsh How Much Output Will We Produce? - Over last 12 yrs, US economy produced average of about $10 trillion worth of goods and services per year - Why didn’t production average $18 trillion per year? Or just $6 trillion? - In classical approach, we start at beginning: markets for reources The Labor Market real wage is amount of goods workers can buy with hour’s earnings. Labor supply curve indicates how many people will want to work at various real wage rages - upward slope tells us the greater the real wage, the greater the number of people who will want to work - the labor supply curve slopes upward because, as the wage rate increases, more and more individuals are better off working than not working. Thus, a rise in the wage rate increases the number of people in economy who want to work- to supply their labor Labor Demand - Labor demand curve - shows number of workers firms will want to hire at any real wage - in deciding how much labor to hire, a firm’s goal is to earn greatest possible profit: difference betweens sales revenue and costs - As wage rate increases, each firm in economy will find that, to maximize profit, it should employ fewer workers than before. When all firms behave this way together, a rise in wage rate will decrease quantity of labor demanded in economy Equilibrium Total Employment - real wage adjusts until quantities of labor supplied and demand are equal - In classical view, economy achieves full employment on its own
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Sheila Walsh From Employment to Output - How much output will workers produce? Answer depends on...
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