Chapter 24 Flashcards
Three Schools of Macroeconomic Thought
Classical Macroeconomics
Keynesian Macroeconomics
Monetarist Macroeconomics
Classical Macroeconomics
Adam Smith
Keynesian Macroeconomics
John Maynard Keynes
Monetarist Macroeconomics
Milton Friedman
Austrian School of Economics
F.A. Hayek
Classical Macroeconomics
The view that the market economy works well, that aggregate fluctuations are a natural consequence of an expanding economy and that government intervention cannot improve the efficiency of the market.
The Macroeconomic Debate during the Great Depression
During the depression, the classical view of macroeconomics was challenged. Classical macroeconomists predicted that the Great Depression would eventually end in the long run, but the new Keynesian school of thought sought to provide a fix in the short term.
Keynesian Macroeconomics
The view that the market economy is inherently unstable and needs active government intervention to achieve full employment and sustained economic growth.
This environment gave rise Milton Friedman who was a lead proponent of
Monetarism in the 1960s and 1970s.
Monetarists Macroeconomics
The view that the market economy works well, that aggregate fluctuations are a natural consequence of an expanding economy, but that fluctuations in the quantity of money generate the business cycle.
Potential GDP
is the value of real GDP when all the economy’s factors of production—labor, capital, land, and entrepreneurial ability—are fully employed.
Why is Potential GDP so Important
- When the economy is at full employment, real GDP equals potential GDP; so actual real GDP is determined by the same factors that determine potential GDP.
- Real GDP can exceed potential GDP only temporarily as it approaches and then recedes from a business cycle peak. So potential GDP is the sustainable upper limit of production.
- Real GDP fluctuates around potential GDP, which means that on the average over the business cycle, real GDP equals potential GDP.
The Production Function
At any given time, the quantities of capital, land, and entrepreneurship and the state of technology are fixed. But the quantity of labor is not fixed. It depends on the choices that people make about the allocation of time between work and leisure.
The Production Function – Diminishing Returns
The production function displays diminishing returns—each additional hour of labor employed produces a successively smaller additional amount of real GDP.
Like any market, the labor market is determined by:
The Demand,
The Supply, and
The Equilibrium
