Macro Chapter 17

Presentation 1- Keynesian/Classical/Monetarist

Balance of Payments

Classical Economics

• Started with Adam Smith in 1776• Dominant theory of economics through the

1930s• Belief that “Laissez-Faire Economics” is best---

government should let it be because full employment is the norm

Classical Economics Contd

• The AS curve is vertical and is the sole determinant of output

• The downsloping AD curve is stable and determines the price level

Classical Economics

Pric

e Le

vel

P2

P1

Qf

Classical Theory

Real Domestic Output

AS

AD1

AD2

a b

c

Say’s Law

• The idea that supply creates its own demand• When supplying goods, workers earn money

and then spend $$ on goods/services• $$ that is saved is then loaned out and spent

as well

Keynesian View

• Product prices and wages are downwardly inflexible

• AD is unstable• Government intervention is needed to

maintain economic stability• Horizontal AS curve up to QfAnd then it is vertical or Upsloping intermediate range

Keynesian Economics

Pric

e Le

vel

P1

QfQu

Keynesian Theory

Real Domestic Output

AS

AD1

AD2

y x

Theory of Rational Expectations

• The idea that people learn to anticipate government interventions

• They act according to how the government will act

• Ex- if people expect government spending or the $$ supply to increase (which increases AD and P) they will demand more wages to offset the inflation which will negate the gov’t policy

Monetarist View

• Changes in the money supply are the greatest determinant of economic growth and the business cycle.

• The government should keep the money supply fairly stable to control inflation- expand the money supply slightly over time to keep up with growth

Quantity Theory of Money

• Velocity and Q are stable (in the MV = PQ equation)

• Increasing the money supply will have a direct effect on price (increase)

Balance of Payments

• A net statement of all international flows of money over a given period of time

Balance of Payments Cont’d

Comprised of:1. Current-Account balance = trade balance +

services balance + transfers 2. Financial (Capital) Account Balance = foreign

purchases of home assets – home purchases of foreign assets

3. Official Reserves- the balance of current and financial accounts

***BOP always equals Zero***