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
quantity of labor demanded
is the total labor hours that all the firms in the economy plan to hire during a given time period at a given real wage rate.
demand for labor
is the relationship between the quantity of labor demanded and the real wage rate when all other influences on firms’ hiring plans remain the same.
quantity of labor supplied
is the number of labor hours that all the households in the economy plan to work during a given time period at a given real wage rate.
supply of labor
is the relationship between the quantity of labor supplied and the real wage rate when all other influences on work plans remain the same.
The Labor Market Equilibrium
From the firm’s perspective
From the household’s perspective
From the firm’s perspective:
If an additional hour of labor produces at least as much additional output as the real wage rate, a firm hires that labor.
From the household’s perspective:
Households are willing to supply labor only if the real wage rate is high enough to attract them from other activities i.e. opportunity cost.
The Natural Rate of Unemployment
is the amount of frictional and structural unemployment.
The fundamental causes of these unemployment rates are:
Job Search
Job Rationing
Job search
is the activity of looking for an acceptable vacant job
The amount of job search depends on various influences, but the main factors are:
Demographic Change
Unemployment Benefits
Structural Change
Demographic Change
working age population
Unemployment Benefits
opportunity cost of job search
Structural Change
technological changes
Job Rationing
occurs when the real wage rate is above the full-employment equilibrium level.
The real wage rate might be set above the full-employment equilibrium level for three reasons:
Efficiency wage
Minimum Wage
Union Wage
Efficiency wage
incentivized wage rate
Minimum Wage
government regulated minimum (i.e. price floor)
Union Wage
collective bargaining agreement
