Ch11 - Classical And Keynesian Econ Flashcards
Primary difference between Keynesian and classical economics…
Classical - at or trending toward full employment
Keynesian - trending toward, away from, or at full Employment.
What is the supply demand relationship in classical Econ?
Supply creates its own demand. (Says law)
What is the Classical relationship between Investment and Savings?
I = S
What is equilibrium price?
The price that clears the market.
Classical economists view on unemployment…
Unemployment is a function of surplus labor; it’s temporary and flexible wages mean no involuntary unemployment.
What is Classical Equilibrium?
Where Aggregate Demand = Aggregate Supply you have full employment.
What is aggregate demand?
Total value of real GDP that all sectors of the economy are willing to purchase at flexible prices.
In the Loanable funds model what is interest?
The price of money
In the Loanable funds model, what slope is the “Demand for loans”?
Downward sloping
In the Loanable funds model, what direction is the slope of “supply of funds”?
Upward slope
Where is the “Equilibrium” on the Loanable funds model?
Where the demand for loans equals the supply of funds.
Demand for loans is driven by what 3 things?
Changes in:
- perceived business opportunities.
- Govt spending.
- expectations about future inflation.
Supply of Loanable funds is driven by what 3 things?
Changes in:
- Private savings
- Capital inflows
- Expectations about future inflation.
In classical system equilibrium what are prices and wages?
Flexible, and trend towards equilibrium
Aggregate demand has what kind of relationship between price level and amount of output demanded?
Inverse relationship.
Why does aggregate demand curve have a downward slope?
- Real balance effect
- Interest rate effect
- Foreign purchases effect
What are the primary determinants of Aggregate demand?
Changes in:
- Consumer spending (change in wealth)
- Investment spending (change in interest rates, expected returns)
- Gov spending
- Net Export spending (change in world income or exchange rates)
What is aggregate supply?
Amount of real output firms will produce at each price level.
Long run aggregate supply curve is what shape at full employment output?
Vertical
Why does the Short run aggregate supply curve slope upwards?
Rising costs of per unit production as output increases.
What are the 4 determinants of aggregate supply?
- Changes in wages
- Changes in commodity prices
- Productivity
- Changes in other factors that affect production costs (taxes, regulation, etc.)
Why is the LRAS supply curve vertical?
Changes in aggregate price have no effect on aggregate output.
What is LRAS potential output?
Level of real GDP possible assuming all prices including nominal wages are fully flexible
What happens when LRAS actual aggregate output exceeds the potential output?
Nominal wages rise ➡ SRAS curve shifts left ➡ higher price level at potential output.
What happens when LRAS actual aggregate output falls below potential output?
Nominal wages fall➡SRAS curve shifts right➡lower price level at potential output
Classical system recession wants how much gov action?
None; the economy is self adjusting with flexible prices.
Classical econ say the fall in Aggregate Demand will cause business to do what?
Lower prices to clear the market until equilibrium with lower prices.
What was Keynes’ 3 critiques of Classical Econ?
- S=I is not true, interest rates are not locked to savings or investment behavior.
- Wages not flexible downward (labor unions decrease flex)
- Prices not always downward flexible - some businesses will wait out recession.
What was Keynes’ view of Full Employment Equilibrium?
Economy doesn’t trend toward full employment equilibrium; can be below, above, or at full employment equilibrium.
Keynes thought what about demand/supply?
Economy is demand driven - companies only produce what it thinks the market will purchase.
Income-Expenditure model
GDP=C+I
GDP=C+I planned+I unplanned
GDP=AE+I unplanned
What is equilibrium in the Income-Expenditure model?
When planned aggregate expenditure = Real GDP
What happens when planned aggregate spending is greater than real GDP?
Unplanned inventory is negative and business respond by increasing output.
What happens when planned aggregate spending is less than real GDP?
Unplanned inventory is positive and businesses decrease output.
Keynes’ view of equilibrium?
Equilibrium (GDP=C+I) doesn’t have to happen at Full Employment Output.
How would Keynes offset demand shock?
Use of Fiscal and Monetary policy.
