Macro 24 philips curve and quantity theory of money

Question 1

define neoclassical economics?

Answer 1

Updated version of the classical school of thought whose main believes include free market economics.

Question 2

What did the neoclassicals think the supply was shaped like?

Answer 2

LRAS - inelastic.

Question 3

What happens if AD increases according to the neoclassical model

Answer 3

AN increase in AD will move the economy beyond its capacity. leading to a positive output gap. This is possible in the short run by utilising overtime. At this point, because prices are high, workers will demand higher wages to ensure wages rise in line with inflation. As wages rise, the costs of production rises and the SRAS curve shifts to the left. The higher COP makes output less profitable at each price, so firms are no longer willing to produce at P2. This process continue until output returns to Y1 with the end result being an increase in PL but no changes in output.

(OPPOSITE FOR AD DECREASING AND LEADING TO PL FALLING)

Question 4

In summary, what do the neo-classicals believe about the market?

Answer 4

That the market always clears without any need of government intervention.
In order to increase GDP in the long run, the economy needs to increase the productive capacity by improving quantity/quality of FOP.

Question 5

define keynesian economics?

Answer 5

Economic growth is strongly influenced by AD.

Question 6

Describe the features of the elastic part of the Keynesian AS curve?

Answer 6

Lots of spare capacity.
Low inflation.
High unemployment.

Question 7

Describe the features of the unit-elastic part of the Keynesian AS curve?

Answer 7

Increase in output and inflation.
Decreasing unemployment.

Question 8

Describe the features of the inelastic part of the Keynesian AS curve?

Answer 8

No spare capacity - output can’t increase.
High inflation.
Low unemployment.

Question 9

What are the 3 key points we can take from the keynesian theory of aggregate supply?

Answer 9

1. The economy doesn’t always come back to full employment. This is because people don’t take wage cuts.
2. Employees are like to be protected by unions and contracts.
3. In times of low animal spirits, firms wont hire workers even if they are cheaper.

Question 10

define the phillips curve?

Answer 10

Shows a trade-off between inflation and unemployment.

Question 11

how does the phillips curve look?

Answer 11

Question 12

What is stagflation?

Answer 12

When an economy is facing high unemployment and high inflation. This happens when supply shifts left.

Question 13

What is the breakdown of the phillips curve?

Answer 13

The findings of Phillips in The relationship between unemployment and the rate of change of wages in the United Kingdom, suggested there was an inverse correlation between the rate of change in money wages and unemployment. For example, a rise in unemployment was associated with declining wage growth and vice versa.

Question 14

who re-invigorated the quantity theory of money?

Answer 14

Milton Friedman - as a response to stagflation

Question 15

what does the quantity theory of money suggest?

Answer 15

An increase in money supply increases inflation.
It is endorsed by Monetarists (Milton) who believe that controlling the money supply is essential to control inflation.

Question 16

What is the formula for QTM?

Answer 16

MV=PQ.

Where:
M = money supply.
V = velocity of circulation (fixed).
P = price level.
Q = quantity of goods and services (fixed) .

MV measures AD.
PQ measures AS.

Question 17

why must MV = PQ?

Answer 17

Because what we make, we have to buy. Must be in equilibrium.

Question 18

Under these assumptions, what will happen to inflation if AD and AS increase at the same rate?

Answer 18

Inflation will not change.

Question 19

Why do some economists believe that the phillips curve is outdated?

Answer 19

Because the relationship has become weaker:
1. Supply side policies have broken down the relationship (1993-2007).
2. Globalisation - increased supply of labour led to falling wages and an increase in competition led to lower prices.

Question 20

What are the 3 main arguments keynesians put towards the QTM?

Answer 20

1. Keynesians say V is not fixed because demand can fall, especially in a recession.
2. Assumes PQ (AS) always equals MV (AD). But in a recession, AS>AD, and so not always in equilibrium.
3. Keynesians say other reasons for inflation exist, such as cost push factors.