The Two Pillars of Classical Economics

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Del curso dictado por University of California, Irvine

The Power of Macroeconomics: Economic Principles in the Real World

1271 calificaciones

University of California, Irvine

The Power of Macroeconomics: Economic Principles in the Real World

1271 calificaciones

In this course, you will learn all of the major principles of macroeconomics normally taught in a quarter or semester course to college undergraduates or MBA students. Perhaps more importantly, you will also learn how to apply these principles to a wide variety of situations in both your personal and professional lives. In this way, the Power of Macroeconomics will help you prosper in an increasingly competitive and globalized environment. This course is also available in Portuguese. To join the fully translated Portuguese version, visit this page: https://www.coursera.org/learn/macroeconomia-pt/

De la lección

The Aggregate Supply-Aggregate Demand Model and the Classical-Keynesian Debate

Keynesian Economics is Born7:00

The Two Pillars of Classical Economics 6:44

Why Classical Economics Failed 2:23

The AS-AD Framework 4:03

Why the AS and AD Curves Shift 7:37

Three Ranges of the Economy 7:05

Conoce a los instructores

Dr. Peter Navarro
Professor
Paul Merage School of Business

[MUSIC]

To understand why Keynesian economic triumphs,

it is important to understand how the two major pillars of classical

economics crumble under the of Keyen's argument.

There two pillars are Say's Law, and the Quantity Theory of Money.

Let's start with Say's Law.

It was formulated in the 1800s by French businessman Jean Baptiste Say,

and popularized by British stockbroker David Ricardo.

Say's Law says quite simply that supply creates its own demand.

Well that sounds good, but what does it really mean?

Think about it this way.

When people work to produce goods and services, they earn income for doing so.

Say's Law states that the total income generated by this work

must equal the value of the goods and services.

Thus, if the workers spend this income,

it must be enough to pay for all the goods and services they produce.

Therefore, supply creates its own demand.

Or, in the parlance of macro economics,

there must be enough aggregate demand for the available aggregate supply.

Now right off the bat, there's a problem with Say's Law.

Suppose that the income earners don't spend all their money, and

instead save some of it.

That's exactly the problem that Thomas Malthus raised in his critique of

Say's Law.

Malthus said that if people didn't spend all of their money,

there would be a general glut of goods and people would be out of work.

You've probably heard of Malthus before because he's famous for the Malthusian

doctrine that population will grow faster than the production of food.

And that this will lead to mass starvation.

In fact, it was Mathus' dark vision that originally

earned the economics profession it's label as the dismal science.

Well, John Say and David Ricardo had an answer for

Malthus, and it was simply this.

It doesn't matter if people save some of their money,

because all of these savings will, in turn, be invested in the economy.

Therefore, aggregate demand,

which equals consumption plus investment, will always equal aggregate supply.

We can follow the logic of Say's Law by looking at

the circular-flow diagram in this figure.

In the figure, the employee compensation paid to workers,

the rents paid to land owners, the interest paid to money lenders, and

the profits earned by business owners, together represent

the total income earned by all the people producing aggregate supply.

This flow of income moves from right to left at the top of the figure,

from business firms to households.

And, it represents aggregate supply in Say's Law.

On the demand side we see several arrows at the bottom of the figure.

One arrow moves from left to right, and

represents consumer purchases of goods and services from businesses.

A second arrow shows consumer savings moving first into the banking and

finance sector, and then emerging as investment by businesses.

Together consumption plus investment equals aggregate demand in Say's Law.

Say's law became a tenant of classical economics.

It didn't say unemployment couldn't exist, but it did say if wages and prices and

interest rates were allowed to adjust, unemployment would go away on its own.

Classical economists but

their Say's Law analysis with the quantity theory of money.

The quantity theory of money determines the price level,

while Say's Law analysis determines real output.

The Quantity Theory of Money is based on the so called, Equation of Exchange.

This may equation may be written as M*V = P*Q, M of course, equals the money

supply, V is the velocity of money or

amount of income generated each year, by a dollar of money.

P is the general price level as measured by an index such as the consumer price

index, and Q is the quantity of real outputs sold.

While P * Q on the right side of the equation equals the nominal or

inflation adjusted output of the economy, as measured by the Gross Domestic Product.

In its simplest terms.

The quantity theory of money says that

the price level varies in response to changes in the quantity of money.

Put another way,

changes in the price level are caused by changes in the money supply.

The money supply goes up 20% prices go up 20%.

If the money supply goes down 5% prices go down 5%.

To better understand this point, we have to understand

two important classical assumptions about the quantity theory of money.

The first is that velocity is constant.

The second, known as the Veil of Money assumption,

is that real output is not influenced by the money supply.

That is, it doesn't matter how much money the government prints, it will not

increase the amount of goods and services that the economy can actually produce.

now Looking at the MV equals PQ equation why must it be that given

these assumptions increasing the money supply m will only lead to inflation.

Clearly, if the Velocity V is constant on the left side of the equation, and

output Q on the right side of the equation is unaffected by the money supply,

the only thing that can change if the money supply M changes,

is the price level P.

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