Ch 10 Lo_economic_instability

8/17/2019 Ch 10 Lo_economic_instability

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Economic Instability:

A Critique of the Self-Regulating Economy

Del Mar College, John Daly!""! South-#estern $ublishing, A Di%ision of &homson 'earning


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(uestioning the Classical

$osition• Accor)ing to *eynes, it +as ossible for sa%ing to

increase an) aggregate )eman) to fall

•

In)i%i)uals sa%e an) in%est for a host of reasons,an) that no single factor, li.e the interest rate,lin.s these acti%ities

• Sa%ing is more resonsi%e to changes in income

than to changes in the interest rate• In%estment is more resonsi%e to technological

changes, business e/ectations, an) inno%ationsrather than the interest rate


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*eynes on Interest Rates

• 0oth sa%ing an)in%estment )een) on anumber of factors that

may be far moreinfluential than theinterest rate

• &he interest rate isimortant in )eterminingthe le%el of in%estment,

but other %ariables aremore imortant such asthe e/ecte) rate of rofit


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*eynes on #age Rates

• Emloyees +ill naturallyresist an emloyer1sefforts to cut +ages

• #ages may be infle/iblein a )o+n+ar) )irection

• &he economy is inherentlyunstable 2 it may not

automatically cure itself ofa recessionary ga

• &he economy may not beself-regulating


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3e+ *eynesians an) #age Rates

• Many critici4e) *eynes because it )i)n1t offer arigorous an) comlete e/lanation of infle/ible

+ages• 'ong-&erm labor contracts are often a)%antages

for both emloyers an) +or.ers

• &hese contracts ha%e costs, but many belie%e the

benefits clearly out+eigh the costs• #or.ers an) Emloyers use 'ong-&erm contracts

for mutually beneficial a)%antages


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3e+ *eynesians an) #age Rates

• Efficiency +age mo)els

ro%i)e a soli)

microeconomic

e/lanation for infle/ible

+ages an) thus are

caable of e/laining +hy

continuing unemloyment

roblems e/ist in someeconomies


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*eynes on $rices

• &he internal structure

of an economy is not

al+ays cometiti%eenough to allo+ rices

to fall


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Is it a (uestion of the &ime it

&a.es for #ages to A)7ust8• #ages an) rices are not fle/ible 9in a )o+n+ar)

)irection an) may not a)7ust )o+n+ar) in a

recessionary ga• Many economists to)ay ta.e a osition bet+een

*eynes an) the classical economists ;or them,the question is not +hether +ages an) rices are

fle/ible )o+n+ar), but ho+ long it ta.es for the+ages an) rices to a)7ust

• &he *eynesian osition is the time is long enoughto say that the economy is not self-regulating

Instea), the economy is inherently unstable: it cane/ist in a recessionary ga for a long time


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*eynesians an) &he


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( = A

• #hat )o *eynesians mean +hen they saythe economy is inherently unstable8

• 5#hat matters is not +hether the economyis self-regulating or not, but +hether ricesan) +ages are fle/ible an) a)7ust quic.ly6Comment on this statement

• Accor)ing to *eynes, +hy might aggregate)eman) be too lo+8


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&he *eynesian ;rame+or. >f

Analysis• *eynes +as intereste) in the le%el of total

e/en)itures 9&E in general, but he +as

articularly concerne) +ith Consumtion• Consumtion )een)s on )isosable income

• Consumtion an) )isosable income mo%e in the

same )irection

• #hen )isosable income changes, consumtion

changes by less


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&he Consumtion ;unction

• ConsumtionAutonomous Consumtion B

marginal roensity to consume multilie)

by )isosable income• CCo B M$C9)

• M$C is equal to the change in consumtion

)i%i)e) by the change in )isosable income

• M$C ∆ C ∆ )


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&he Consumtion ;unction

• Consumtion can be

increase) in three

+ays:? Raise autonomous

consumtion

! Raise )isosable

income

@ Raise the M$C


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&he M$C an) the M$S

• Marginal roensity to sa%e is the ration of

change in sa%ing to the change in

)isosable income• M$S ∆ S ∆ )

• It also follo+s that since CBS ), then :

M$SBM$C?


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Deri%ing a &otal

E/en)itures

Cur%e• As )isosable

income rises, so

)oesconsumtion

• In%estment

remains constant

•


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Comaring &otal E/en)itures

an) &otal $ro)uction• &here are three ossible otions:

? &otal E/en)itures e/cee)s &otal

$ro)uction

! &otal $ro)uction e/cee)s &otal

E/en)itures

@ &otal E/en)itures equals &otal

$ro)uction


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Can the Economy be in a Recessionary


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&he Multilier

• Autonomous sen)ing is any e/en)iture that isnot relate) to a change in income or Real


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&he Multilier an) Reality

• ;irst, the multilier ta.es time to ha%e an

effect &his rocess can ta.e months

• Secon), for the multilier to increase Real


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#hat Does the *eynesian Aggregate

Suly Cur%e 'oo. 'i.e8• If aggregate

)eman) rises fromAD? to AD!, Real


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( = A

• Go+ is autonomous consumtion )ifferent

from consumtion8

• #hat haens in the economy if total ro)uction 9TP is greater than total

e/en)itures 9TE 8

• If the MPS equals "!@, then +hat )oes themultilier equal8

Ch 10 Lo_economic_instability

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