Economic Shools Of Thought Flashcards
Managing the business cycle
Policy intervention
Objective high and stable growth
Supply side policies
Increasing potential output (LRAS)
Demand side (fiscal and monetary)
Affect aggregate demand
Used to mitigate the effects of economic recessions and booms
Market oriented policies
Policies to increase aggregate supply by freeing up the market
E.g.
Reducing government expenditure
Tax cuts
Effects on supply of labour
Effects on demand
Tax cuts for business
Cutting taxes on profits
Greater tax relief for investment
Reducing power of labour (increased flexibility of labour markets)
Reducing welfare payments
Policies to encourage competition
Privatisation
Deregulation
Free trade and capital movements
Interventionist supply side policies
Policies to increase aggregate supply by gov intervention to counteract the deficiencies of the market
Types Funding R&D Training and education Information,advice and persuasion Assistance to small firms Nationalisation Direct provision
Policy making key questions
1)Labour market
Right wing- keep prices and wages flexible
Left wing allow for price and wage rigidities
2)Should the state try to stimulate AD during recession to promote growth
Right wing can’t do
Left wing yes should do
3) how do expectations affect market behaviour
Right wing- expectations adjust rapidly to changes in prices - expansions in AD then should lead to inflationary pressure
Left wing- expectation of prices depends on expectations of output and employment
(What should we do (if anything) to promote high growth, low inflation, low unemployment
And shall we use demand or supply side policies
Main schools of thought
Classical economists- free markets clear, no intervention
Keynesian economists- free markets don’t clear, intervene!
Monetarist economists- free markets work, any interventions should focus on long run
Classical key elements
Price flexibility ensures that D=S
In the labour market and market for loanable funds
Says law - supply creates its own demand
The quantity theory of money
Classical on labour and capital markets
Classical analysis on output and employment
Free market works
Markets clear in the long run:
Labour market
-full employment in the LR
-frictional unemployment only
Market for loanable funds
Interest rates will adjust to ensure market clearing
-C(-) > S(+) > (through r ) I(+)
Classical on price and inflation
Quantity of money theory
General level of prices depends on money supply
Inflation is then purely a monetary phenomenon
Implications for monetary policy
Policy implications of classical
Monetary (at best ) does not work extra money causes inflation m
Fiscal policy (at best) does not work
Gov expenditure must come from extra taxes, extra borrowing, or extra money
Extra taxes and extra borrowing reduce private AD by the same amount
Extra money causes Inflation
Keynes on labour markets
They do not clear on their ow
Keynes on labour markets
Keynes rejection of classical theory
Markets won’t clear
Rigidities in the labour market
The problem of deficiency of demand
Workers are also consumers
When you cut wages you also affect AD
This offsets any benefits and puts the economy deeper into recession
Keynes on capital markets
Savings,consumption and animal spirits
Rejection of increased savings as a means of increasing investment
More savings less consumption
Less consumption means less sales for firms
Which deters investment (the paradox of thrift )
S and I are not just tested through r
Behaviour is motivated by perceptions of how others will behave (animal spirits )
Keynes on says law
Demand rules!
Keynesians emphasise the role of AD
Says law”supply creates its own demand “
Keynes - no AD can drop and this reduction can cause AS to drop as well (at least for some time )
Keynes on inflation
More money does not automatically lead to high inflation
Keynes on prices
Classical economists
MV=PY
Hence more M should lead to higher P (inf)
Keynes
Not necessarily
Depends on the position of the AD curve
