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Classical Economics
A school of thought that provides insights into the economy when it operates at or near full employment.
Supply-Siders
Economists / politicians who emphasize the role of taxation for influencing economic activity.
Tries to explain why there are booms and busts in the economy.
REMEMBER!
With the classical model, wages and prices are assumed to adjust freely and quickly according to the laws of supply and demand.
The total of all machines, equipment and buildings in the economy. The total effort of all employed workers in an economy Y = Income = GDP
Labor (L)
Y = F(K,L)
Y = F (K,L)
Aggregate Production Function: How much output is produced from the inputs of capital or labor.
In most situations we assume capital is fixed at a constant level! LABOR is the only variation that changes the level of output in the economy!
Suppose that output is produced with two or more inputs and that we increase one input while holding the other inputs fixed. Beyond some point called the point of diminishing returns output will increase at a decreasing rate.
Show how much output is produced when capital stock is constant and labor varies.
The wage paid to workers adjusted for changes in prices. What determines the REAL WAGE?
Reduce activity
IDEAL!
Huh!?
Marginal Benefit: Benefit a firm receives from hiring an additional worker is the VALUE of the EXTRA OUTPUT from the hiring.
Huh?!
Marginal Cost: Is the REAL WAGE a firm pays to hire the additional worker
If real wages fall, then MB > MC and more people can get employed.
SITUATION: Workers have to decide how many hours they want to work and how much leisure time they want.
Make working more attractive and raise the opportunity costs of NOT working.
Higher wage raises workers income for the same hours worked. Workers may choose more leisure over work.
SO: Y = F (K,L)
Potential output increases as the supply of labor increases or the stock of capital increases. Liberal immigration plans will shift the labor curve RIGHT and lead to higher level of employment. OUTPUT increases. Investors are happy Voters are happy
Jean Baptiste Say, David Ricardo, John Stuart Mill, Thomas Malthus, etc. ACTUALLY a term created by Keynes to contrast his theory from theirs. Theories from 18th early 20th Century.
Says Law
The doctrine that states that supply creates its own demand. Demand would always be sufficient to purchase the goods and services produced.
Questions to ponder:
Why would Says Law appeal to classical economists? Could you give an example of Says Law? Why would Says Law apply to the labor situation in the US?
Would you agree or disagree with the statement that undocumented workers do the jobs Americans dont want to do.
Taxes only to cover infrastructure (small) More independence for individuals / businesses Trickle-down taxes
Economist Arthur Laffer said YES! KEEP IN MIND! Laffers example was with net exports and tariffs. Politicians applied it to income taxes / payroll taxes!
Laffers Curve
IF government RAISES the tariff taxes on imports they will actually collect LESS tax, because no one can afford the goods.
Inverse relationship
Capital Gains: Profit you get from selling a stock at a higher price than you bought it at. Since the tax on capital gains is too high, people dont sell their stock bringing down Y and decreasing govt. revenue.
Some politicians say lowering or removing the capital gains tax would increase Y and maybe other ways to tax people since they will have more jobs.
Theory that emphasizes how shocks to technology an cause fluctuations in economic activity.
Changes in technology will change the level of full employment or potential output. Adverse developments will cause shocks that cause output and employment to fall.
Very influential Very controversial Doesnt explain some historical situations. Makes the assumption that labor is always at equilibrium between demand and supply.
Other models handle unemployment. So far, it hasnt made it into the macro policy circles.
Y = f(L,K) In a full employment economy, total GDP is determined by the factors of production (K).
CROWDING OUT.
NOTE: US Consumes 67% of its GDP and invests a smaller portion than Germany or Japan.
Is it due to savings rates cutting into consumption? Is it due to higher payroll taxes cutting into Consumption?
Closed Economy: No international trade. Increasing government spending comes at the expense of other uses of GDP.
Crowding out
An economy with international trade. Government spending does not need to crowd out either C or I What does get crowded out?
Net exports
Crowding In?
Decreases in Govt. spending means other aspects of C, I, X-M are going to crowd in
C or I will increase if G decreases. BUT inflationary pressures will be on. There is no leakage for the excess money.