2. 1 © ©1999 South-Western College Publishing PowerPoint Slides prepared by Ken Long Principles of Economics 2nd edition by Fred M Gottheil

3. 2 Chapter 28 Can Government Really Stabilize the Economy? 12/24/2015 © ©1999 South-Western College Publishing

4. 3 This chapter discusses principles associated with Automatic Stabilizers © ©1999 South-Western College Publishing Phillips Curve Analysis The Supply-Side School on Employment and Inflation The Rational Expectations School on Employment & Inflation The Neo-Keynesian School on Employment and Inflation The Keynesian School on Employment & Inflation The Classical School on Employment & Inflation

5. 4 What are the basic Schools of Economic Thought? Classical Keynesian Monetarism Rational Expectations © ©1999 South-Western College Publishing Supply-side neo-Keynesian

6. 5 What is Classical Economics? Because the economy is always tending toward a full employment equilibrium, there is no need for government intervention © ©1999 South-Western College Publishing

7. 6 What are the two propositions of Classical Economics? 1. All markets are basically competitive 2. All prices are flexible © ©1999 South-Western College Publishing

8. 7 How do the Classical Economists explain unemployment? Unemployment is a temporary situation caused by wage rates climbing above equilibrium © ©1999 South-Western College Publishing

9. 8 What about the long-run? Wage rates will adjust, bringing about full employment in the long-run © ©1999 South-Western College Publishing

10. 9 S W1 Q1 D1 W2 Q2 Real Wage and Employment 9 © ©1999 South-Western College Publishing

11. 10 According to Classical Economists, why might unemployment be persistent? People interfere with the competitive process © ©1999 South-Western College Publishing

12. 11 How do people interfere with the competitive process? Unions Minimum wage laws © ©1999 South-Western College Publishing

13. 12 According to Classical Economists, what should the government do during periods of unemployment? NOTHING © ©1999 South-Western College Publishing

14. 13 How do the Classical Economists explain inflation? © ©1999 South-Western College Publishing Money supply increases

15. 14 14 © ©1999 South-Western College Publishing P = MV Q Prices Money Velocity GDP

16. 15 Who controls the level of money and therefore the price level? The Federal Reserve © ©1999 South-Western College Publishing

17. 16 How much should the Fed increase the money supply? Approximately equal to the long-run full employment rate of growth, about 3% © ©1999 South-Western College Publishing

18. 17 What is Keynesian Economics? Government intervention when the economy is in a less than full employment equilibrium © ©1999 South-Western College Publishing

19. 18 According to the Keynesians, why do we have unemployment? Unemployment is the result of insufficient aggregate demand © ©1999 South-Western College Publishing

20. 19 What is the solution to Unemployment? Use government’s fiscal policies to increase aggregate demand © ©1999 South-Western College Publishing

21. 20 Where does the money come from to increase aggregate demand? The government practices deficit spending © ©1999 South-Western College Publishing

22. What is a Recessionary Gap? The difference in real GDP between a less than full employment equilibrium and the real GDP at the full employment equilibrium © ©1999 South-Western College Publishing

23. Recessionary Gap Real GDP C+I+G less than full employment C+I+G Aggregate Expenditure full employment © ©1999 South-Western College Publishing

24. 23 What is the New Deal? President Roosevelt’s policies of the 1930’s to increase aggregate demand by stimulative fiscal policies © ©1999 South-Western College Publishing

25. 24 What is the Employment Act of 1946? Congress officially declares that it is the continuing policy and responsibility of the federal government to take an active role in the economy © ©1999 South-Western College Publishing

26. 25 How do the Keynesians view inflation? They are not worried about inflation © ©1999 South-Western College Publishing

27. 26 What is the Economics of Fine-Tuning? The government becoming more proficient at fiscal policy, managing deficit and surplus budgets to create full employment equilibrium with no inflation © ©1999 South-Western College Publishing

28. 27 For what were the Keynesians ill prepared? The stagflation of the 1970’s, when we had high rates of both unemployment and inflation © ©1999 South-Western College Publishing

29. 28 How do the views of Keynesians differ from those of neo-Keynesians? The neo-Keynesians emphasized the possibility that an economy can be in equilibrium at less than full employment with inflation © ©1999 South-Western College Publishing

30. 29 What is the Phillips Curve? A graph showing the inverse relationship between the economy’s rate of unemployment and the rate of inflation © ©1999 South-Western College Publishing

31. 30 30 © ©1999 South-Western College Publishing Rate of Inflation Rate of Unemployment The Phillips Curve

32. 31 According to the neo- Keynesians, what is the relationship between inflation and unemployment? © ©1999 South-Western College Publishing

33. 32 The neo-Keynesians believe that a fall in the unemployment rate causes the rate of inflation to increase, and a rise in the rate of inflation causes the rate of unemployment to decrease © ©1999 South-Western College Publishing

34. 33 What is the significance of the Humphrey- Hawkins Act of 1978? It modified the Full Employment Act of 1946, altering its role to now promote a livable point on the Phillips curve © ©1999 South-Western College Publishing

35. 34 What caused an increase in costs in the 1970’s? OPEC increased the world price of oil © ©1999 South-Western College Publishing

36. 35 How do the neo- Keynesians explain the 1970’s Phillips Curve Instead of one Phillips curve, there was a set of Phillips curves © ©1999 South-Western College Publishing

37. 36 36 © ©1999 South-Western College Publishing Rate of Inflation Rate of Unemployment The 1970’s Phillips Curve

38. 37 What is the Rational Expectations School? Government’s policy of managing aggregate demand is undermined because of people’s anticipation of consequences © ©1999 South-Western College Publishing

39. 38 What is an example of the negative effect of anticipation? When workers anticipate an increase in aggregate demand, they will bargain for higher wages to protect them from inflation © ©1999 South-Western College Publishing

40. 39 What does the long-run Phillips curve look like? It is effectively vertical © ©1999 South-Western College Publishing

41. 40 What policy implications are associated with the rational expectations school? Government cannot increase employment in either the short or long run. © ©1999 South-Western College Publishing

42. 41 What is the Laffer Curve? Increasing tax rates from zero increases tax revenues up to a point - beyond that point increases will shrink the economic pie because of disincentives © ©1999 South-Western College Publishing

43. 42 42 © ©1999 South-Western College Publishing Tax Rate Tax Revenue The Laffer Curve

44. 43 An increase in taxes might lead to lower tax revenues What is the point to the Laffer Curve? © ©1999 South-Western College Publishing

45. 44 What is Crowding Out? A fall in private investment spending caused by an increase in government spending © ©1999 South-Western College Publishing

46. 45 How can government borrowing cause Crowding Out? Interest rates can be driven up, leaving less money available for private investment © ©1999 South-Western College Publishing

47. 46 What are Automatic Stabilizers? Structures in the economy that tend to add to aggregate demand when the economy is in a recession, and subtract during inflation © ©1999 South-Western College Publishing

48. 47 What are some examples of Automatic Stabilizers? Unemployment benefits The progressive income tax © ©1999 South-Western College Publishing

49. 48 48 © ©1999 South-Western College Publishing http://www.whitehouse.gov http://stats.bls.gov/eag.table.html http://www.bog.frb.fed.us/releases/ h15/data/m/prime.txt http://thomas.loc.gov http://www.bls.gov http://www.westegg.com/inflation

50. 49 What are the basic Schools of Economic Thought?What are the basic Schools of Economic Thought? What is Classical Economics? What is Keynesian Economics? According to the Keynesians, why do we have unemployment?According to the Keynesians, why do we have unemployment? What is the Employment Act of 1946? What is neo-Keynesian Economics? What is the Phillips Curve?

51. 50 What is Demand-side Inflation? What is Supply-side Inflation? What is the Rational Expectations School?What is the Rational Expectations School? What is Supply-side Economics? What is the Laffer Curve? What is Crowding Out? Upon what do economists agree? What are some examples of Automatic Stabilizers?What are some examples of Automatic Stabilizers?

52. 51 ENDEND © ©1999 South-Western College Publishing