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Published byDonald Owen Modified over 9 years ago
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Theories, Models, and The Fundamental Macro Debate zOur first venture into theories and models in macroeconomics. zTheory -- An assertion about the causes of observed behavior, in order to predict outcomes. zModel -- A formalization of a theory, done to make concise predictions.
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Classical Versus Keynesian Macroeconomic Theories -- The Fundamental Debate
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Classical Thought -- The Economy (Adam Smith) zClassical Macroeconomics -- Because the nominal wage rate (W), prices (P), and interest rates (i) are flexible, the economy will automatically correct itself without need of policy.
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Classical Response to a Sluggish Economy (Y < Y N ) zW labor more attractive to hire zP goods and services cheaper to purchase zi cheaper cost of borrowing, prompting more durable goods consumption and investment
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Keynesian Thought -- The Economy (1936) zKeynesian Macroeconomics -- Because the nominal wage rate (W), prices (P), or interest rates (i) are inflexible, the economy will not automatically correct itself, and therefore needs overt policy.
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Possible Reasons for Inflexibility or Stickiness zW long-term labor contracts zP costly for firms to change prices for goods and services they produce zi Federal Reserve target variable for monetary policy
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Practical Thoughts -- Classical Vs Keynesian zThere are several Keynesian models, all based upon inflexibility. zWas the Great Depression an aberration? zWhat better represents the macroeconomy? zHow long is the short-run?
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