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Classical vs Keynesian Perspectives on Equilibrium● Can the economy get stuck?○ Keynesian view: Yes■ Unemployment equilibrium -the economy has reached a point ofmacroeconomic equilibrium somewhere below full potential output, whichresults in sustained unemployment■ Ping pong ball down carpet stairs, the ping pong ball needs help.■ The economy has lots of equilibrium points with highunemployment, there will always be structural and frictionalunemployment○ Classical View: No■ Faith in the invisible hand■ Be patient - Laisse Faire■ Market will fix itself■ Moving a ball in a pool - will eventually end up in the same spot.Determinants of Planned Investment(income, interest rates, expectations)● Planned investments - amount businesses plan to spend no matter what● Interest rates - when interest rates go up, planned investments go down. Wheninterest rates go down, planned investments go up.● Future expectations○ If a business believes that demand will increase, they will invest in moreinventory.○ Paradox of thrift■ The paradox states that an increase in autonomous saving leads to adecrease in aggregate demand and thus a decrease in gross output whichwill in turn lower total saving.Classical Theory of Deficits (and critique)● Government borrowing comes at the expense of private borrowing.● Could increase inflation, if more money is printed to finance debt.● Deficits require borrowing by selling bonds● If federal reserve prints money to buy wtreasury bonds, this is called monetizingthe deficit● Risk of Crowding out → Gov’t borrowing increases the total amount of borrowing● which increases the interest rate and decreases planned investment.● Is crowding out an issue?○ Keynesians - emphasize business expectations in the determination ofplanned investment more than interest rates○ Gov’t should borrow and spend to create jobs and jump start the○ economy○ Exploding debt and historically low interest ratesDebt & Deficits Contexts● US tax payers are responsible for debt, banks will be looking at the GDP as security onhow we are going to pay the debt back● Social security holds alot of this debt. We are 28 trillion in debt. 22 is publicly heldand the rest is held outside the US. US corporations that are situated outside ofthe US hold a significant amount of debt.● We are doing better than other countries in terms of debt. Debt as a percentageof GDP is small.● How does History support the argument that debt isn't bad?○ Higher debt after WW2, and then a boom came with

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UMass Amherst ECON 104 - Econ Exam 3 Study Guide

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