Classical and Keynesian Macro Analyses

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Chapter 11
Classical and Keynesian Macro Analyses


Among the many factors influencing the rate of GDP growth is the volume of business regulation. Concerns about terrorism have multiplied the amount of documentation that must accompany cargo arriving in U.S. ports. How does this affect real GDP?

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Learning Objectives
Discuss the central assumptions of the classical model Describe the short-run determination of equilibrium GDP and the price level in the classical model Explain the circumstances under which the short-run aggregate supply curve may be either horizontal or upward-sloping

Learning Objectives
Understand what factors cause shifts in the short-run and long-run aggregate supply curves Evaluate the effects of aggregate demand and supply shocks on equilibrium real output in the short run Determine the causes of short-run variations in the inflation rate Slide 11-4

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Chapter Outline
The Classical Model Equilibrium in the Labor Market Keynesian Economics and the Keynesian Short-Run Aggregate Supply Curve Output Determination Using Aggregate Demand and Aggregate Supply

Chapter Outline
Determinants of Aggregate Supply Effects of a Weaker Dollar

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Did You Know That...
Different approaches to economic analysis have different views of price flexibility? The Keynesian approach emphasizes the idea that prices of final goods and services may be slow to respond to higher input prices? Slide 11-7

The Classical Model
The classical model was the first attempt to explain fluctuations in: – – – – – – – Inflation Output Income Employment Consumption Saving Investment

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The Classical Model
Assumptions of the classical model
– Pure competition exists – Wages and prices are flexible – People are motivated by self-interest – People cannot be fooled by money illusion

The Classical Model
Consequences of the assumptions
– Minimize the role of government in the economy – If all prices and wages are flexible, any problems in the macroeconomy will be temporary – The power of the market will keep the economy at full-employment in the long run

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The Classical Model
Say’s Law
– Supply creates its own demand. – Producing goods and services generates the means and the willingness to purchase other goods and services.

Equating Desired Saving and Investment in the Classical Model 14 Interest Rate (percent) 12 10 8 6 4 2 0 600
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Desired Saving

Desired Investment



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Figure 11-2

Investment and Saving per Year ($ billions)


Equating Desired Saving and Investment in the Classical Model Summary
– Changes in saving and investment create a surplus or shortage in the short run. – In the long run, this is offset by changes in the interest rate. – This interest rate adjustment returns the market to equilibrium where S = I.

The Classical Model
– Would unemployment be a problem in the classical model?

– No, classical economists assumed that the wage would always adjust to the full employment level.

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Example: Will Low Rates of Personal Saving Choke Off Investment Spending? Personal saving rates have fallen dramatically in the U.S. over the past decade. But rates of gross private domestic investment are steady. Firms have been able to access sources of financing other than personal saving, such as their own retained earnings and funds invested by foreigners. Slide 11-15

The Classical Model of the Labor Market

Figure 11-3

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The Classical Model of the Labor Market

Classical Theory and Vertical Aggregate Supply
In the classical model, long-term unemployment is impossible The long-term aggregate supply curve is the only one the matters. Rapid adjustment of prices and wages will move the economy to an equilibrium position on the long-run curve.

Table 11-1...
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