Lesson 8 Macro Theories Keynesian Classical Copyright 2004

Lesson 8 Macro Theories Keynesian Classical Copyright© 2004 South-Western

Summary • There are two basic schools of thought in Economics. . 1. Classical 2. Keynesian Copyright © 2004 South-Western/Thomson Learning

1. Classical – the natural market forces 2. Keynesian – solving problems with market intervention – money. Copyright © 2004 South-Western/Thomson Learning

1. 2. 3. 4. Classical – the hidden hand Keynesian – the helping hand Classical – the natural market forces Keynesian – solving problems with market intervention – money. Copyright © 2004 South-Western/Thomson Learning

Keynesian Economics 1 v Keynesian economists generally argue that, as aggregate demand is volatile and unstable, a market economy will often experience inefficient macroeconomic outcomes in the form of economic recessions (when demand is low) and inflation (when demand is high) and stagflation!!! These can be mitigated by economic policy responses, Copyright © 2004 South-Western/Thomson Learning

Keynesian Economics 1 • Monetary policy actions by the CB and fiscal policy actions by the government, which can help stabilize output over the business cycle. • Keynesian economists generally advocate a managed* market economy – predominantly private sector, with an active role for government intervention particularly during recessions and depressions. • As opposed to Free Copyright © 2004 South-Western/Thomson Learning

• (New) classical theorists demanded that macroeconomics be grounded on the same foundations as microeconomic theory, profit -maximizing firms and rational, utilitymaximizing consumers. • 10 principles of Economics + Economic Theorists Copyright © 2004 South-Western/Thomson Learning

Quantitative Easing Copyright © 2004 South-Western/Thomson Learning

Impact of Currency Devaluation • Devaluation. . • Valuation of currencies • • Shows “value” of relative economies GDP growth Productivity Efficient use of factors of production Copyright © 2004 South-Western/Thomson Learning

Why Devaluation Increasing net imports = more imports than exports… Copyright © 2004 South-Western/Thomson Learning

Impact of Currency Devaluation What will happen to Supply Side? What will happen to Aggregate Demand Copyright © 2004 South-Western/Thomson Learning

Fiscal Policy • Direct taxes – on incomes on Wealth • Normally progressive • Indirect taxes – on spending - buying • Not normally on essentials such as food • Hybrid on output Value added Tax Copyright © 2004 South-Western/Thomson Learning

Fiscal Policy • Value added Tax • Difference between input costs and output prices • EG. Copyright © 2004 South-Western/Thomson Learning

Fiscal Policy • Tax avoidance • Tax evasion Copyright © 2004 South-Western/Thomson Learning

The Multiplier Effect • Government spending of increased taxes on supply side will increase income and then lead to increase in consumer spending Copyright © 2004 South-Western/Thomson Learning