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Macroeconomic Theory The Business Cycle • The business cycle refers to the ups and downs in the economy • Sometimes the economy grows so fast that inflation drives up prices • Sometimes the economy slows down in a recession with rising unemployment Recession and Inflation • Recession is at least six months of “negative growth” in the economy, with rising unemployment and declining output • Inflation is at least six months of rising general price levels • Because it takes six months to know if we are in a recession or inflationary period, we say there is a recognition lag of 6 months Classical Economics • Classical Economics is based on three ideas: – Say’s Law Supply creates its own demand – Self-regulating markets laissez-faire no government interference – Equation of exchange Ms x V = P x Y Money Supply x Velocity = Price x output The Aggregate Demand Aggregate Supply Model • See graph on the board Questioning Classical Economics • Thomas Malthus and population growth • Karl Marx and the evil of profit Historic Business Cycle • Series of “panics” – 1819 panic – 1836-1843 depression – 1857 panic – 1869-1871 panic – 1893 panic – 1901 panic – 1929 Great Depression The Great Depression • The Stock Market crash of 1929 • The Smoot Hawley Tariff Act • Drought • The Hoover Administration A New School of Economics • John Maynard Keynes • The General Theory of Employment, Interest and Money The Total Expenditure Model • See graph on the board Keynesian Economic Plans • Recession: • Increase government spending • OR • Decrease taxes • Inflation: • Decrease government spending • OR • Increase taxes Keynesian Multipliers • Government multiplier • =1/(1-mpc) • Tax multiplier • =mpc/(1-mpc) Keynesian Fiscal Policy • 1. Identify gap (recession or inflation) and amount • 2. Find mpc • 3. Calculate multipliers • 4. Calculate needed policy change: – Gap = Gov’t spending x multiplier – Gap = Tax change x mulitiplier Deficits and Debt • If the government spends money it doesn’t have (hasn’t collected in taxes) the government runs a deficit • Add all the deficits together from 1776 until today and you have the National Debt • http://www.usdebtclock.org/ • http://www.babylontoday.com/national_de bt_clock.htm The National Debt National Debt Problems • Foreign owned sector is increasing • 40% of the National Debt is now held by our own government, so we’ll have to pay taxes to pay ourselves • 22% of the National Debt is held by other countries and we’ll have to tax ourselves to pay those other countries Assets and Liabilities • • • • Remember Accounting 1000? Assets and Liabilities The National Debt is a Liability Where’s the National Asset Clock? What did we buy with our National Debt? What else (besides government) makes economies grow? • Capital “Deepening” – More “capital per worker” can make those workers more productive and increase output • Labor Growth – More workers • Technological Progress – New ways of doing things, new inventions which are more efficient National Budget • The past administration ran up huge deficits and added trillions to the National Debt. The current administration is doing the same. • Could you do better? Try your hand at balancing the Federal Budget by playing the Budget Game at http://www.nathannewman.org/nbs/ Budget Simulation • After trying the Budget Simulation, describe the results of your budget. This one page essay is due on Class Session 10. • Don’t print out the results of your budget changes, just summarize the changes you made.