terms.docx

CLASSICAL THEORY Say's Law: each product generates demand in the economy equal to its own value and as a result, total demand equals total supply Ex. producing a dollar's worth of bread generates a dollar's worth of purchasing power consisting of wages, rent, interest, and profit. Supply creates its own demand The income a person receives from production is spend to purchase goods and services produced by others Total production equals total income (aggregate supply equals aggregate demand) General overproduction or a deficiency in aggregate expenditure is impossible Economy is self-correcting (its markets always clear) and thus the economy automatically adjusts to full employment Savings by households (bank deposits) lead directly to spending by businesses on capital or investment goods View interest as a reward for saving No business will borrow (and thereby pay interest) unless it plans to invest in profitable production No household will save (and thereby forgo the pleasure of spending) unless it's offered interest in return The interest rate is flexible (not sticky), thus ensuring that the market for loanable funds always clears quickly Every dollar saved by households is borrowed and invested by businesses Because prices adjust rapidly to their equilibrium levels, there are no surpluses or shortages Demand management policies (govt policies designed to change spending) are ineffective and unnecessary Increased govt spending doesn?t effected total output because of crowding (increase in one facet decreases another) KEYNESIAN THEORY Rejects idea that aggregate expenditure equals aggregate income Rejects idea that economy is rapidly self-correcting An economic system may be in equilibrium at less than full employment at prolonged periods of time If economy experiences drop in aggregate expenditure, there will be a consequent decline in real output and resource use If economy experiences increase in aggregate expenditure, there will be a consequent rise in real output and resource use Saving and investing are undertaken by different groups for different reasons Businesses save and borrow to invest in factories, equipment, and inventories Interest rate is not a mechanism that brings about equality of saving and investment at full employment Prices and wages tend to be sticky and not flexible causing output and employment to bear the impact of changes in total spending During recession we seldom hear about declining prices and wages (as a result output and employment would remain close to full-employment levels) Reduction in real wages of all workers throughout the economy will have no effect on aggregate expenditures The level of aggregate output is determined by the level of aggregate expenditure The level of aggregate expenditure may not always be high enough to ensure a full-employment level of aggregate output NEOCLASSICAL SCHOOL OF THOUGHT Markets should be free; creates better economic outcomes There should not be any govt intervention in terms of buying, selling, pricing, etc. Markets will reach ?equilibrium: if all sellers who want to sell at or below a given price have sold to all buyers who are willing to buy at or above a given price; price is determined in market