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VCCS ECO 120 - Viewpoints and Models

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Viewpoints & ModelsSlide 2Slide 3Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Slide 15Slide 16Slide 17Slide 18Viewpoints & ModelsInflation & UnemploymentSlide 21Slide 22Macroeconomic Viewpoints SummarySlide 24Slide 25•Classical EconomicsPopularly accepted theory prior to the Great Depression of the 1930s.Says the economy will automatically adjust to full employment.•Classical economists assume that:–Supply creates its own demand (Say’s Law)–Wages and prices are flexible –Savings always equals investment,Viewpoints & Models•Classical Economics (cont.)Viewpoints & ModelsFIGURE 9-1Aggregate Supply and Aggregate Demand in Classical Economics•Keynesian EconomicsJohn Maynard Keynes, aggregate spending helps determine the level of macroeconomic activity.Macroeconomy seeks an equilibrium output level.•Macroeconomic Equilibrium–Amount of total planned spending on new goods and services equals total output in the economy.If aggregate spending > current production, then output, employment, and income will all increase.•Inventories–Stocks of goods on hand.–Allows for spending to exceed current production.Viewpoints & Models OutputTotal Spending Injections – LeakagesEconomic Condition$0.00 0.750.50 0.501.00 1.251.50 1.502.00 1.752.50 -0.503.00 2.25Total OutputTotal Spending Injections – LeakagesEconomic Condition$0.00 0.75 0.75Expansion0.50 1.00 0.50Expansion1.00 1.25 0.25Expansion1.50 1.50 0.00Equilibrium2.00 1.75 -0.25Contraction2.50 2.00 -0.50Contraction3.00 2.25 -0.75Contraction•Keynesian Economics (cont.)Viewpoints & ModelsTABLE 9-1Total Output and Total Planned Spending (Trillions of Dollars)3.002.502.001.501.000.500 1.00 2.00 3.003 6 9Planned consumption(trillions of $)Real disposable income(trillions of dollars)691231245º45º lineCDis-savingSavingSavingsSavingsConsumptionConsumption•Keynesian Economics (cont.)Viewpoints & ModelsFIGURE 9-2Equilibrium in the Macroeconomy•Keynesian Economics (cont.)Use government expenditures and taxes to control the level of economic activity.•A recession could be counteracted by increasing aggregate spending through:–Increasing government expenditures on goods and services–Increasing transfer payments–Lowering taxesViewpoints & Models•Keynesian Economics (cont.)Viewpoints & ModelsFIGURE 9-3Changes in Macroeconomic Equilibrium•New Classical EconomicsReturn to the basic classical premise that free markets automatically stabilize themselves and that government intervention in the macroeconomy is not advisable.Brought about by what some argued to be holes in Keynesian economics principles, which could not explain or remedy some problems of the 1970s.•Stagflation–Occurs when an economy experiences high rates of both inflation and unemployment.More sophisticated explanations of aggregate demand and aggregate supply.Viewpoints & Models•New Classical Economics (cont.)Downward-sloping aggregate demand curve was explained through:•Interest Rate Effect–Interest rate moves with changes in overall prices.–An inverse relationship exists between the interest rate and the amount people borrow and spend.•Wealth Effect–In order to maintain the same amount of accumulated wealth, people spend less when prices rise and more when prices fall.•Foreign Trade Effect–A direct relationship exists between changes in overall prices in an economy and spending on imports that diverts spending from domestically produced output.Viewpoints & Models•New Classical Economics (cont.)Viewpoints & ModelsAggregate Demand in the New Classical Model•New Classical Economics (cont.)Aggregate supply curve could be viewed in two ways:•Short-run supply with three phases–At low levels of output, the aggregate supply curve is perfectly horizontal.–As output increases beyond a certain point, a direct relationship between prices and output is established.–At high levels of output, the aggregate supply curve becomes perfectly vertical.•Long-run supply–Perfectly vertical at the natural rate of unemployment, the point to which the economy will move.Viewpoints & Models•New Classical Economics (cont.)Viewpoints & ModelsFIGURE 9-5Aggregate Supply in the New Classical Model•New Classical Economics (cont.)Long Run Policy Implications•Natural Rate Hypothesis–Over the long run, unemployment will tend toward its natural rate, and policies to reduce unemployment below that level will be ineffective.•Adaptive Expectations–Households and businesses base their expectations of the future on past and current experiences.•Rational Expectations–Households and businesses base their expectations of future policies on how they think they will be affected by these policies.Viewpoints & Models•New Keynesian EconomicsBuilds on the Keynesian view that the economy does not automatically return to full employment.Regards prices and wages as inflexible (or “sticky”) downward rather than flexible as other schools believe.•MonetarismSchool of thought that favors stabilizing the economy through controlling the money supply.•Supply-Side EconomicsPolicies to achieve macroeconomic goals by stimulating the supply side of the market.Became popular in the 1980s.Viewpoints & Models•Phillips CurveCurve showing the relationship between an economy’s unemployment and inflation rates.Inflation & UnemploymentFIGURE 9-6A Phillips Curve (Hypothetical Data)•Phillips Curve (cont.)Inflation & UnemploymentFIGURE 9-7Annual Rates of Unemployment and Inflation in the United Statesfor 1960–2000 and Representative Phillips Curves•Phillips Curve (cont.)Three factors may help to explain shifts in the Phillips curve:•Structural changes in the labor force–1970s: Increase in the labor force participation rates of women and teenagers who, at the time, had higher unemployment rates than men.–1980s & 1990s: Rate of unemployment for women fell, the movement of teenagers into the market reversed itself, and an increase in the rate of involuntary part-time employment.•Cost-push inflation–1970s & 1980s: Brought about by energy price increases.•Eligibility for government transfer payments–Availability of transfer payments increases unemployment, and vice versa.Inflation & Unemployment•Viewpoints SummaryNo theory is designed to

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