Ch10'Classical

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Ch10.Classical Keynesian Economics

• Chapter Objectives
• Says law
• Classical equilibrium
• Real balance, interest rate, foreign purchases
  effects
• AS in SR and LR, AD
• The Keynesian critique of the classical system
• Equilibrium at varying price level
• Disequilibrium and equilibrium
• Keynesian policy prescriptions

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Ch10.Classical Keynesian Economics

• The Classical Economic System
• (Late 18th century)Says Law Supply creates
  its own demand.
• Without saving, people spend on their money,
  wed never have unemployment. At this case,
  supply demand. Otherwise, some workers must be
  laid off when demand for production falls.
• GDPCI, GDP CS gt I S
• The economy produces a supply of consumer goods
  and investment goods. The people who produce
  these goods spend part of their incomes on
  consumer goods and save the rest. Their savings
  are borrowed by investors who spend this money on
  investment goods. The bottom line is that
  everything the economy produces is purchased.
  This is perfect economic system. Everything
  produced is sold. No one is unemployed.

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Ch10.Classical Keynesian Economics

• The Classical Economic System
• Supply and Demand Revisited
• As long as ADAS, we are at full employment
  according to classical economics theory.
• AD curve depicts an inverse relationship between
  the price level and the quantity of goods and
  services demanded.
• AD is defined as the total value of real GDP
  that all sectors of the economy are willing to
  purchase at various price levels.

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Ch10.Classical Keynesian Economics

• The Classical Economic System
• Supply and Demand Revisited
• Three reasons why the quantity of goods and
  services purchased declines as the price level
  increase
• The real balance effect(price goes up, feel poor,
  asset shrinks, lower spending)
• The interest rate effect(price increases pushes
  up interest rates, lower the consumption of
  certain goods and services and also lower
  investment in new plant and equipment.)
• The foreign purchases effect(price level rises
  relative to the price levels in other countries,
  this tends to increase our imports and lower our
  exports. Since our dollar is appreciated, we can
  buy more foreign goods and import more.while
  foreign currency is depreciated, foreigner buy
  less our goods, therefore foreign export more and
  import less.

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Ch10.Classical Keynesian Economics

• Supply and Demand Revisited
• The LR AS is defined as the amount of real output
  or real GDP, that will be made available by
  sellers at various price levels.
• Two assumptions
• (1)In the LR, the economy operates at full
  employment.
• (2)In the LR, output is independent of prices.
• We have vertical AS curve, this is what the
  classical economists predicted and is completely
  consistent with Says law supply creates its own
  demand in the long run.
• The Short Run AS curve
• In SR, some unemployment is possible, we may
  operate under full-employment GDP.
• In SR, we have upward sloping supply curve, why?
  In the SR, higher prices mean higher profit
  margins, which give business firms like yours an
  incentive to increase output.

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Ch10.Classical Keynesian Economics

• Is it possible that output continues to rise even
  after we have exceeded full employment GDP? Yes,
  it is possible in the SR. However, in the long
  run, AS curve is vertical.
• AD and AS dont remain constant. During
  recession, they decline as an economy grows,
  they grow too.
• The Keynesian Critique of the Classical System
• Classical economists believed the government
  should intervene in the economic affairs as
  little as possible.
• Keynes asked if supply creates its own demand,
  why we are having a world wide depression. What
  if saving is not equal investment?
• Keynes believed three possible equilibriums
  existed below full employment, at full
  employment, and above full employment.
• He believed that full employment was hardly
  inevitable.
• Modified Keynesia AS curve(figure 10, page 226)
• AD1 represents a very low level of aggregate
  demand,(recession and depression)

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Ch10.Classical Keynesian Economics

• AD2 curve shows the same full-employment
  equilibrium
• AD3 represents excessive demand, which would
  cause inflation.
• The Keynesian System
• Demand creates its own supply
• AD is our economys primer mover.
• The Keynesian Aggregate Expenditure Model
• Keynesian model assumes a constant price level
• The consumption and saving functions
• consumption function As income rises,
  consumption rises, but not as quickly.
• Saving function As income rises, saving rises,
  but not a s quickly.
• Investment sector A decline in profit
  expectations, or, as Keynes puts it, in the
  marginal efficiency of capital, causes recessions.

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Ch10.Classical Keynesian Economics

• Disequilibrium and equilibrium
• AD exceeds AS
• AS exceeds AD
• Summary ADAS, when the two are not equal, as
  must adjust to bring the economy back into eqlm.
• Do exercise in the class.

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Ch11. Fiscal Policy the National Debt

• Chapter Objectives
• The deflationary/inflationary gap
• The multiplier and its applications
• Automatic stabilizers
• Discretionary fiscal policy
• Budget deficit and surpluses
• The public debt

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Ch11. Fiscal Policy the National Debt

• The deflationary/inflationary gap
• AD is the sum of all expenditures for goods and
  services(CIGX).
• AS is the nations total output of final goods
  and services.
• Full employment GDP is the level of spending
  necessary to provide full employment of our
  resources.
• A deflationary gap occurs when equilibrium GDP is
  less than full -employment GDP.
• Equilibrium GDP is the level of spending that the
  economy is at or is tending toward.
• See figure 1 page 241
• Equilibrium GDP is greater than full employment
  GDP when theres an inflationary gap.
• Keynes would sugg0est cutting G and raising
  taxes.
• In sum, when theres a deflationary gap, eqlm GDP
  is too small when theres an inflationary gap,
  it is too big. (multiplier effect)

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Ch11. Fiscal Policy the National Debt

• SUMMARY If spending is too high, eqlm GDP is
  above the full employment level. To eliminate the
  inflationary gap, we cut G and /or raise taxes.
  If equilibrium GDP is less than full-employment
  GDP, we raising G and /or cutting taxes.
• The Multiplier and Its Applications
• Multiplier 1/(1-MPC)
• MPCMPS 1
• Applications of the multiplier
• New GDP Initial GDP (change in spending X
  multiplier)
• Multiplier (distance b/e eqlm GDP- full
  employment GDP)/gap

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Ch11. Fiscal Policy the National Debt

• The Automatic Stabilizers
• Personal income and payroll taxes
• During recession, as incomes fall, federal
  personal income and social security tax receipts
  fall even faster.
• Personal Savings
• During recession, saving declines during
  prosperity, saving rises.
• Credit Availability
• credit availability helps people to go through
  recessions.
• Unemployment Compensation
• The Corporate Profits Tax
• During recessions, corporations pay much less
  corporate income taxes.
• Other Transfer Payments

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Ch11. Fiscal Policy the National Debt

• Discretionary Fiscal Policy
• Making the automatic stabilizers more effective
• Public works
• Transfer Payments
• Changes in Tax Rates
• Changes in Government Spending
• Who makes fiscal policy?
• The Deficit Dilemma
• A surplus is created when the tax revenue is
  greater than government spending.
• A deficit is created when the government is
  paying out more than its taking in.

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Ch11. Fiscal Policy the National Debt

• Why Are Large Deficits So Bad?
• (1) They raise interest rates, which in turn,
  discourages investment.
• (2) The federal govnt has become increasingly
  dependent on foreign savers to finance the
  deficit.
• (3) Less saving available to large corporate
  borrowers seeking funds for new plant and
  equipment.
• (4) Continuing deficits keep adding to the
  national debt.
• The Public Debt
• The public or national debt is the amount of
  currently outstanding federal securities that the
  Treasury has issued. It is the cumulative total
  of all the federal budget deficits less any
  surpluses.
• About 10 of the debt is held by various federal
  agencies, most notably the Fed. The public debt
  is what the fed owes to the holders of Treasury
  bills, notes, bonds, and certificates.

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Ch11. Fiscal Policy the National Debt

• The Public Debt
• Who holds the national debt?
• When do we have to pay off the debt? We dont.
• A real problem would arise if investors thought
  the government might go bankrupt.
• Isnt the national debt getting too big? Too big
  relative to what?
• 1980--33 1997--68
• Why not go ahead and pay off the debt- or at
  least reduce it?
• It would have catastrophic consequences.
• High unemployment, budget deficit when
  inflation becomes a problem, we need to run
  budget surpluses, paid off part of the debt.
• How serious a problem is the interest on the
  debt? (1/7 of the federal budget.
• What is the limit? Who sets that limit?
  Foreigners.Lose some part of your sovereignty,
  lose your independence.