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Economic Ideologies AREAS OF DISPUTE • WHAT CAUSES INSTABILITY IN THE ECONOMY? • IS THE ECONOMY SELF-CORRECTING? • SHOULD GOV’T HAVE RULE SOR USE DISCRETION IN SETTING ECON POLICY? Classical Economics • Otherwise known as Conservative Economics. • Emphasizes role of profit incentives in creating new products and industries. • Prefers free market solutions to economic problems. Classical Economics cont’d • Believes the economy is selfregulating. • Assumes prices, wages and interest are (or should be) flexible. • Believes capitalism promotes economic growth, innovation, efficiency and raises standards of living. • Believes gov’t policies can crowd-out business investment and fail because of timing lags. • LAISSEZ FAIRE • ADAM SMITH; RICARDO, MILL, SAY’S LAW • NATURAL LAWS OF ECONOMICS – – – – PRIVATE PROPERTY/PRIVATE INTEREST FREEDOM OF TRADE FULL EMPLOYMENT IS THE NORM SHORT TERM PROBLEMS FIX THEMSELVES IN THE LONG RUN – Say’s Law- supply creates its own demand Liberal Economics • Otherwise known as Keynesian Economics. • Believes free markets do not solve high unemployment. • Believes that instability is inherent in capitalism. Liberal Economics cont’d • Believes demand for goods is central for understanding the rise or fall of production. • Emphasizes inflexibility of prices and wages because of institutional constraints. Maintains that inflexibility is necessary or not easily changed. • Believes the economy can remain stuck in recession or depression. • Believes capitalism can be “repaired” by governmental action. KEYNESIAN ECON CONTINUED • • • • ECONOMY NOT SELF CORRECTING AGGR. DEMAND DETERMINES OUTPUT WAGES INFLEXIBLE DOWNWARDS ACTIVE GOV’T INTERVENTION FIXES AN UNSTABLE ECON. • INSTABILITY IN THE ECONOMY CAUSED BY INVESTMENT CHANGES Radical Economics • Otherwise known as Marxian Economics or Communism. • Emphasizes built-in structural problems that will cause capitalism to change. • Emphasizes the importance of social classes: workers and owners. Radical Economics cont’d • Believes low wages can cause too little demand for products. • Believes technology can worsen working conditions for workers. • Believes unemployment and imperialism will occur under capitalism. • Believes reforms to capitalism cannot completely fix the system. MONETARISM • MILTON FRIEDMAN • MV=PQ; VELOCITY IS STABLE • ECONOMY IS STABLE IN LR AT NATURAL RATE OF EMPLOYMENT • FISCAL POLICY HAS NO AFFECT • INSTABILITY OF ECONOMY IS CAUSED BY INCORRECT MP Real Business Cycle Theory • Focus on aggregate supply • Business cycle caused by supply factors like productivity • Decline in GDP means less demand for money-----supply of money decreases – AD falls – Price is the same because AS also fell COORDINATION FAILURES • Instability occurs because “people do not reach a mutually beneficial equilibrium” • Don’t coordinate their actions • Firms and households have a “disconnect” • Expectations different? RATIONAL EXPECTIONS • ROBERT LUCAS • PRICES ADJUST INSTANTLY • PEOPLE ACT IN RESPONSE TO EXPECTATIONS • RECESSIONS SELF CORRECTING • INFLATION IS ALWAYS ANTICIPATED • Self correction • Lower prices don’t change real output even in the SR RULES OR DISCRETION • POLICY RULES—REDUCE INSTABILITY – MONETARY RULE—EXPAND MONEY SUPPLY EACH YEAR AT THE SAME ANNUAL GROWTH RATE OF GDP – PROMOTE STEADY GROWTH – CONSTITUTIONAL AMENDMENT FOR A BALANCED BUDGET? PROS OF DISCRETION • VELOCITY OF MONEY TOO UNSTABLE--MP CAN HELP CHANGE AD IN SR • BALANCED BUDGET AMENDMENT WOULD MAKE RECESSION WORSE BY FORCING TAXES TO INCREASE AND GOV’T SPENDING TO DECREASE EFFICIENCY WAGE THEORY • IF HAVE A HIGH TURNOVER OF LABOR OR HIGH COST OF SUPERVISION, THEN MARKET WAGE NOT EFFICIENCY WAGE – 1-GREATER WORK EFFORT – 2-DECREASED SUPERVISION COST – 3-DECREASED TURNOVER **add to inflexibility of the wages INSIDER-OUTSIDER PROBLEM • DURING A RECESSION – INSIDER—HAS JOB – OUTSIDER—LAID OFF • UNDERBIDING OF EXISTING WAGES TO GET JOB BACK • WAGES INFLEXIBLE DOWNWARD WHEN AGGR. DEMAND DECLINES