Chapter 9 – Macroeconomic Viewpoints
ECONOMICS
THEORY AND PRACTICE
Seventh Edition
Patrick J. Welch
&
St. Louis University
Gerry F. Welch
St. Louis Community College
at Meramec
PowerPoint Presentation by:
Dr. Ray Everett
Pima Community College
Copyright © 2004 John Wiley & Sons, Inc. All rights reserved.
Macroeconomic Viewpoints & Models
Contents
Macroeconomic Model Building
Viewpoints & Models
Inflation & Unemployment
Macroeconomic Viewpoints Summary
Macroeconomic Viewpoints & Models
Chapter Objectives
• To understand that there are several major macroeconomic models
with different assumptions that focus on different relationships.
• To recognize the historical dimension of macroeconomic theory.
• To discuss the fundamental relationships of the classical, new
classical, Keynesian, new Keynesian, and monetarist schools of
through.
• To describe the classical aggregate demand-aggregate supply model
and its conclusions.
• To understand the basic relationships in the Keynesian model, the
concept of macroequilibrium and the factors that influence it, and the
policy implication of the model.
• To explain the aggregate demand curve, the difference between shortrun and long-run aggregate supply, and the policy implications of the
new classical model.
• To identify the basic focus of new Keynesian economics and of
monetarism.
• To introduce the Phillips curve, examine U.S. rates of inflation and
unemployment, and identify reasons for shifts in the Phillips curve.
Macroeconomic Model Building
• Model Building Overview
 Much of the work of economists is model building.
 Models help to explain the relationship between
economic variables and help to answer why economic
problems or conditions occur.
 Model building consists of:
•
•
•
•
Identifying variables
Establishing assumptions
Collecting and analyzing data
Interpreting conclusions
9-1
Viewpoints & Models
• Classical Economics
 Popularly accepted theory prior to the Great Depression
of the 1930s.
 Says the economy will automatically adjust to full
employment.
• Classical economists assume that:
– Supply creates its own demand in a macroeconomy.
– Wages and prices are flexible and increase or decrease to
ensure that the economy operates at full employment.
– Savings always equals investment, because changes in
the interest rate bring savings and investment into
equality.
9-2a
Viewpoints & Models
• Classical Economics (cont.)
FIGURE 9-1
Aggregate Supply and Aggregate Demand in Classical Economics
9-2b
Viewpoints & Models
• Keynesian Economics
 Based on the work of John Maynard Keynes, who
focused on the role of aggregate spending in determining
the level of macroeconomic activity.
 Introduced the idea that a macroeconomy seeks an
equilibrium output level.
• Macroeconomic Equilibrium
– Occurs when the amount of total planned spending on
new goods and services equals total output in the
economy.
 If aggregate spending is greater than current production,
then output, employment, and income will all increase,
assuming that full employment has not been reached,
and vice versa.
• Inventories
– Stocks of goods on hand.
– Allows for spending to exceed current production.
9-2c
Viewpoints & Models
• Keynesian Economics (cont.)
TABLE 9-1
Total Output and Total Planned Spending (Trillions of Dollars)
9-2d
Viewpoints & Models
• Keynesian Economics (cont.)
FIGURE 9-2
Equilibrium in the Macroeconomy
9-2e
Viewpoints & Models
• Keynesian Economics (cont.)
 Keynes pioneered the idea of using government
expenditures and taxes to control the level of economic
activity.
• He believed that a recession could be counteracted by
increasing aggregate spending through:
– Increasing government expenditures on goods and
services
– Increasing transfer payments
– Lowering taxes
9-2f
Viewpoints & Models
• Keynesian Economics (cont.)
FIGURE 9-3
Changes in Macroeconomic Equilibrium
9-2g
Viewpoints & Models
• New Classical Economics
 Return to the basic classical premise that free markets
automatically stabilize themselves and that government
intervention in the macroeconomy is not advisable.
 Brought about by what some argued to be holes in
Keynesian economics principles, which could not explain
or remedy some problems of the 1970s.
• Stagflation
– Occurs when an economy experiences high rates of both
inflation and unemployment.
 More sophisticated explanations of aggregate demand
and aggregate supply.
9-2h
Viewpoints & Models
• New Classical Economics (cont.)
 Downward-sloping aggregate demand curve was
explained through:
• Interest Rate Effect
– Interest rate moves with changes in overall prices.
– An inverse relationship exists between the interest rate
and the amount people borrow and spend.
• Wealth Effect
– In order to maintain the same amount of accumulated
wealth, people spend less when prices rise and more
when prices fall.
• Foreign Trade Effect
– A direct relationship exists between changes in overall
prices in an economy and spending on imports that
diverts spending from domestically produced output.
9-2i
Viewpoints & Models
• New Classical Economics (cont.)
FIGURE 9-4
Aggregate Demand in the New Classical Model
9-2j
Viewpoints & Models
• New Classical Economics (cont.)
 Aggregate supply curve could be viewed in two ways:
• Short-run supply with three phases
– At low levels of output, the aggregate supply curve is
perfectly horizontal.
– As output increases beyond a certain point, a direct
relationship between prices and output is established.
– At high levels of output, the aggregate supply curve
becomes perfectly vertical.
• Long-run supply
– Perfectly vertical at the natural rate of unemployment, the
point to which the economy will move.
9-2k
Viewpoints & Models
• New Classical Economics (cont.)
FIGURE 9-5
Aggregate Supply in the New Classical Model
9-2l
Viewpoints & Models
• New Classical Economics (cont.)
 Long Run Policy Implications
• Natural Rate Hypothesis
– Over the long run, unemployment will tend toward its
natural rate, and policies to reduce unemployment below
that level will be ineffective.
• Adaptive Expectations
– Households and businesses base their expectations of
the future on past and current experiences.
• Rational Expectations
– Households and businesses base their expectations of
future policies on how they think they will be affected by
these policies.
9-2m
Viewpoints
& Models
• New Keynesian Economics
 Builds on the Keynesian view that the economy does not
automatically return to full employment.
 Regards prices and wages as inflexible (or “sticky”)
downward rather than flexible as other schools believe.
• Monetarism
 School of thought that favors stabilizing the economy
through controlling the money supply.
• Supply-Side Economics
 Policies to achieve macroeconomic goals by stimulating
the supply side of the market.
 Became popular in the 1980s.
9-2n
Inflation & Unemployment
• Phillips Curve
 Curve showing the relationship between an economy’s
unemployment and inflation rates.
FIGURE 9-6
A Phillips Curve (Hypothetical Data)
9-3a
Inflation & Unemployment
• Phillips Curve (cont.)
 Three factors may help to explain shifts in the Phillips
curve:
• Structural changes in the labor force
– 1970s: Increase in the labor force participation rates of
women and teenagers who, at the time, had higher
unemployment rates than men.
– 1980s & 1990s: Rate of unemployment for women fell, the
movement of teenagers into the market reversed itself,
and an increase in the rate of involuntary part-time
employment.
• Cost-push inflation
– 1970s & 1980s: Brought about by energy price increases.
• Eligibility for government transfer payments
– Availability of transfer payments increases
unemployment, and vice versa.
9-3b
Inflation & Unemployment
• Phillips Curve (cont.)
FIGURE 9-7
Annual Rates of Unemployment and Inflation in the United States
for 1960–2000 and Representative Phillips Curves
9-3c
Macroeconomic Viewpoints Summary
• Viewpoints Summary
 No theory is designed to explain all the complex
relationships among the players and institutions of a
macroeconomy.
 The economy is not composed of a set of simple
relationships that can be easily manipulated to neatly
solve various problems as they arise.
 Assessing economic theories would be easier if we lived
in closed economies.
• Closed Economies
– Economy where foreign influences have no effect on
output, employment, and prices.
• Open Economies
– Economy where foreign influences have an effect on
output, employment, and prices.
9-4
Chapter 9 – Macroeconomic Viewpoints
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Chapter
ECONOMICS
THEORY AND PRACTICE
Seventh Edition
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