Download Two school of Economics 1. Neo-classical * Free

Two school of Economics
1. Neo-classical – Free market, small gov
2.Keynesian – Use of Gov policy to reach full employment
“Keynesian cross” Y-E model , Y = income, E=expenditure
Keynesian SR model (aka) PAE model ,
SR= short run, Planned aggregate expenditure
Output (GDP) determined by demand
Equilibrium GDP can be > or < full of employment
Equilibrium – Y will not automatically return to Y FE
eg. “prices sticky” or change too slowly to return economy to Y FE
“Keynesian synthesis” (Samuelson)
YS ≡ YD ≡ E ≡ GDP
Q is determined by demand
No supply curve ( ?? In which theory )
Supply does not create its own demand (Says Law)
If YD falls too low, YE < YFE -> cyclical Unemployment
In Keynesian theory, YD always tend to fall too low because of “uncertainty” etc
1. Y must equal to E (shown by 45degree)
2. Some spending on output even when income Y=0
similarly, Io , Go and Xo (X=export, I investment)
3. As Y ↑ → C ↑ → PAE ↑ → Output ↑ (C is Endogenous – within model)
As Y ↑ → PAE ↑ by less (some of the extra Y is saved, spent on imports, etc)
As low Y→ PAE > Y → Y↑ until
Y ↑ → C ↑ → PAE ↑ → Y ↑ .. .
E
YD or PAE
Slope of PAE = d – depends on c,t,m
45
Y
YE
Ao = Co + Io + Go + Xo – Mo – C To
All exogenous spending in economy
Keynes’ General Theory based
drown by Samuelson
Equations : Cauculating YE and changes in YE
YE = (1/(1-d) x Ao (d tells how much spending ↑ as Y ↑)
d= c – ct – m + a
Ao = Co + Io + Go + Xo – Mo – c To
(a=marginal propensity to invest, more output needs more machine)
(1/(1-d) = k, multiplier
so effect of t and To on spending is smaller than equal change in Go, Xo etc
Key Keynesian insight – Increase in exogenous spending increased household income and encourages
higher I by Firms.
For eg, ↑Go causes additional in C and I. Final ∆∆YYmust greater than initial ∆ Go.
∆ Y = ∆Go + ∆C + ∆I
Small fiscal or monetary stimulus can return economy to Yfe, full employment
NB. High saving from extra income reduces multiplier effect. High “marginal propensity to save”.
Similarly, higher rate of income, tax and marginal propensity to import from extra income reduces
multiplier.
GM – Model of Goods market can be used to predict effect of changes of government policy. Also
effect of exogenous shocks. Eg, decrease in export ect.
NB: Keynesian – assumption – price fixed, interest rate, r, assumed constant (despite ∆s in Y). Does not
include financial sector (not a Keynesian Assumption)
↑X → larger ↑Y (multiplier effect)
Y2D
E
Y1D
Ao’
↑∆X
↑Y allows ↑C → final ∆Y> initial ∆X
∆Y= ∆X+ ∆C= ∆X x multiplier
Ao
↔ ↔
Y1E
Y
Y2E