CHAPTER 12 NEW CLASSICAL. RATIONAL EXPECTATIONS. Keynesian economics by John Maynard Keynes (1883-1946) believe that the macro-economy tends towards extended business cycles, with high levels of unemployed factors
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Classical vs Keynesian http://www.economyprofessor.com
SRun Goods market: Ms ↑, aggregate demand ↑, Y* ↑, P*↑.
Labor market: labor demand ↑, wage↑.
LRun Labor market: expected real wage (W/Pe)↓, labor supply ↓
Goods market: aggregate supply ↓, Y* ↓, P* ↑
- assumes labor supply is slow to adjust to price changes
- only reacts in the long-run based on affected new price
New classical: forward-looking
- rational expectation: understanding the relationship between variables
- labor supply make predictions based on available information = anticipated changes in M, G, T, I, …
Keynesian vs New Classical
New Classical Expansionary Policy
New Classical Monetary Surprise
Autonomous change in investment = aggregate demand ↓, Y* ↓, P* ↓ If unanticipated, then Nd (P0) Nd (P’) = P1, Y1
If anticipated, then Nd (P1) + Ns (Ie1) = P0, Y0.
(Based on rational expectation, autonomous changes in investment is unanticipated. If low I is expected to continue, then the supply side will also adjust to restore equilibrium.)
New Classical: Change in Investment
- will not affect output and unemployment
- even in the short-run, labor supply and aggregate supply adjusts quickly to expected price changes
- i.e. expansionary policy shifts aggregate demand and labor demand followed by counter-shifts by labor supply and aggregate supply
Unanticipated policy changes
- may affect output and unemployment
- labor supply and aggregate supply fail to adjust to price changes especially in the short-run
- only aggregate demand and labor demand shifts - results in disequilibrium
Anticipated vs Unanticipated
Output and employment are not affected by anticipated changes in aggregate demand, even in the short-run
New Classical Policy Conclusion