Economics
Classical Model of Price Level
The Classical Model of Price Level is an economic theory that suggests prices are flexible and will adjust to changes in supply and demand. It assumes that markets are always in equilibrium and that any unemployment is temporary. In this model, the economy is self-regulating and will naturally return to full employment without government intervention.
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eBook - ePubMacroeconomics without the Errors of Keynes
The Quantity Theory of Money, Saving, and Policy
- James C. W. Ahiakpor(Author)
- 2019(Publication Date)
- Routledge(Publisher)
A classical alternative to the AS-AD model of the price levelIntroduction
1In his 1939 preface to the French edition of the General Theory , John Maynard Keynes urges economists to discard the Quantity Theory as the explanation of the level of prices because he “regard[s] the price level as a whole as being determined in precisely the same way as individual prices; that is to say, under the influence of supply and demand” (xxxiv). Rather, the Quantity Theory, Keynes argues, should explain the level of interest rates and thus output as a whole:The quantity of money determines the supply of liquid resources, and hence the rate of interest, and in conjunction with other factors (particularly that of confidence) the inducement to invest, which in turn fixes the equilibrium level of incomes, output and employment and (at each stage in conjunction with other factors) the price level as a whole through the influences of supply and demand thus established.(xxxv)2Keynes arrives at these conclusions from (a) setting aside the application of the classical theory of value to money to explain the level of prices in the Quantity Theory of money (see esp. Chapter 21 of the General Theory ) and (b) having failed to recognize a valid theory of interest in classical analysis. In his 1912 and 1913 lecture notes on “The Theory of Money,” Keynes adopts the application of value theory to money to explain money’s value – the level of prices – also declaring the Quantity Theory “absolutely valid ” (1983: 695; italics original).3 The latter problem for Keynes appears to have derived mainly from the classical theory of interest being couched in the language of the supply and demand for “capital” rather than for money (see Keynes’s criticism of Marshall’s restatement of the classical theory of interest in the appendix to Chapter 14 of the General Theory
eBook - PDFEconomics
Theory and Practice
- Patrick J. Welch, Gerry F. Welch(Authors)
- 2016(Publication Date)
- Wiley(Publisher)
The classical aggregate demand–aggregate supply model focuses on the relationship between price and wage levels and output levels. This model concludes that a free market economy’s output level always self‐corrects to full employment and that prices and wages increase and decrease with changes in aggregate demand. Increases in aggregate demand bring increases in prices and wages, and decreases in aggregate demand bring decreases in prices and wages. 4. Keynesian economics gained prominence during the 1930s when John Maynard Keynes introduced the ideas that a macroeconomy can move toward an equilib- rium output level that is less than full employment and that no mechanism is built into the economy to automatically move it toward full employment. Keynes focused on the role of total spending in the economy, indicating that the equilib- rium output level of an economy is a direct result of the level of total spending in the economy. 5. Macroequilibrium occurs in the Keynesian model when total spending equals total current output, or when the leakages from and injections into the spending stream are equal. When spending is greater than the current level of output, which is caused by injections exceeding leakages, the economy expands. When spending is less than the current level of output, which is caused by leakages exceeding injections, the economy contracts. Keynes advocated government intervention, or fiscal policy, to move the economy from equilibrium at low levels of output to equilibrium at a higher full employment level of output. 6. New classical economics was born in the 1970s when many of the world’s economies experienced stagflation and Keynesian economics could not offer an explanation for the serious inflation. New classical economics focuses on an aggregate demand–aggregate supply model similar to the classical model.
eBook - PDFMacroeconomics without the Errors of Keynes
The Quantity Theory of Money, Saving, and Policy
- James C. W. Ahiakpor(Author)
- 2019(Publication Date)
- Routledge(Publisher)
Indeed, the “price level,” being the weighted average of prices of fi nal goods and services, cannot meaningfully be explained in the context of a non-existent aggregate products market. Rather, it should be explained from changes in the prices of goods and services resulting from changes in the demand for, or the sup-ply of, money (cash), as in classical monetary analysis. Restoring the determina-tion of interest rates to the supply and demand for “capital” or credit, inclusive of the rate of a central bank’s money creation, also has the advantage of reconciling some modern analyses with their classical roots, besides guiding the conduct of appropriate monetary policy. The AS-AD model of the “price level” Modern (Keynesian) macroeconomics attempts to determine the “price level” from the intersection of the AS and AD curves. The price level is supposed to rise when either the AD curve shifts to the right, while an upward-sloping or vertical AS curve stays in place, or the AS shifts to the left, while the AD stays in place. A simultaneous rightward shift of the AD curve and a leftward shift of the AS curve also would cause the price level to rise, according to the argument. But 24 A classical alternative to AS-AD supply and demand curves and their shifts are legitimate in explaining prices in individual product markets. The typical market demand curve for a product slopes downwards because there are substitutes for it; without substitutes for a product, its demand curve would be vertical. If sellers of a good charged a higher price than those charged for substitute goods, fewer quantities would be demanded. Similarly, greater quantities of a good would be demanded if its producers lowered their price relative to the prices of substitutes. The same reasoning does not apply to the demand for commodities as a whole for a closed economy. Besides, the assumed downward-sloping AD curve is not independent of pro-duction (income) or supply in the aggregate (AS).
eBook - PDFEffective Demand And Income Distribution
Issues In Alternative Economic Theory
- Marc Jarsulic(Author)
- 2019(Publication Date)
- Taylor & Francis(Publisher)
It illustrates the power of classical theory and suggests that this is a paradigm which still has great potential for development. Classical theory of price 5.2 The classical analysis of prices of production 129 In classical economics the forces of 'supply and demand' were assigned a different role from that which they have in contemporary microeconomics. Instead of explaining how prices and income distribution are simultaneously determined, deviations of supply from demand were invoked to explain why market prices might differ from prices of production. Prices of production were defined as the prices which would exist if, given the technical requirements of production, identical labour was paid an identical wage, all capital earned the competitive rate of profit, and supply were equal to demand. If demand for some good were greater than supply, market price would exceed the price of production. This would cause firms in that industry to earn higher rates of profit than firms in other industries. If this condition persisted, capital would be attracted to the high-profit industry; capacity would increase; and ultimately market price would be reduced. In this sense the price of production was viewed as the 'centre of gravitation' of the price of a good. Encouraged by the work of Sraffa (1960), some economists have begun to examine the idea of prices of production as an explanation of how the relative prices of commodities are determined. An understanding of this approach to pricing and distribution can most easily be obtained by looking at an example. Let us consider an economy in a stationary state, i.e. one where the means of production are fully utilized and are being neither expanded nor contracted. Suppose further that there are two kinds of goods, a consumption good on which the money wage of w per unit of labour is spent, and a capital good which is used in the production of itself and of the consumption good.
eBook - PDF- Tucker, Irvin Tucker(Authors)
- 2016(Publication Date)
- Cengage Learning EMEA(Publisher)
(The classical model is explained in more detail in the appendix to this chapter.) CONCLUSION: When the aggregate supply curve is vertical at the full-employment GDP, the only effect over time of a change in aggregate demand is a change in the price level. Stated simply, the classical view is that “ supply creates its own demand. ” 2 Although Keynes himself did not use the AD – AS model, we can use Exhibit 5 to distinguish between Keynes ’ s view and the classical theory of flexible prices and wages. Keynes believed that once the demand curve has shifted from AD 1 to AD 2 , the surplus (the distance from E 0 to E 1 ) will persist because he rejected price-wage downward flexi-bility. The economy therefore will remain at the less-than-full-employment output of $12 trillion until the aggregate demand curve shifts rightward and returns to its initial position at AD 1 . 2 This quotation is known as Say ’ s Law, named after the French classical economist Jean-Baptiste Say (1767 – 1832). 540 PART 6 | Macroeconomics Theory and Policy Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. ............................................................................................................................................................................................... ............................................................................................................................................................................................................
eBook - PDF- Irvin B. Tucker, Irvin Tucker(Authors)
- 2016(Publication Date)
- Cengage Learning EMEA(Publisher)
(The classical model is explained in more detail in the appendix to this chapter.) CONCLUSION: When the aggregate supply curve is vertical at the full-employment GDP, the only effect over time of a change in aggregate demand is a change in the price level. Stated simply, the classical view is that “ supply creates its own demand. ” 2 Although Keynes himself did not use the AD – AS model, we can use Exhibit 5 to distinguish between Keynes ’ s view and the classical theory of flexible prices and wages. Keynes believed that once the demand curve has shifted from AD 1 to AD 2 , the surplus (the distance from E 0 to E 1 ) will persist because he rejected price-wage downward flexi-bility. The economy therefore will remain at the less-than-full-employment output of $12 trillion until the aggregate demand curve shifts rightward and returns to its initial position at AD 1 . 2 This quotation is known as Say ’ s Law, named after the French classical economist Jean-Baptiste Say (1767 – 1832). 268 PART 4 | Macroeconomics Theory and Policy Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. ............................................................................................................................................................................................... ............................................................................................................................................................................................................
eBook - ePubPaper Money Collapse
The Folly of Elastic Money
- Detlev S. Schlichter(Author)
- 2014(Publication Date)
- Wiley(Publisher)
Part Three Fallacies about the Price Level and Price-Level Stabilization
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Chapter 5 Common Misconceptions Regarding the Price Level
The main reason why the phenomena analyzed in the previous chapters, although powerful and for a long time the intense focus of theoretical investigation, are not at the forefront of present monetary policy discussions is that it is widely believed today that money that is broadly price-level stable, meaning, whose purchasing power as measured by some price index does not decline too rapidly or is not otherwise too volatile, is also “neutral” money, that is, this money should have no distorting or disruptive influences on the real economy. It would not be an exaggeration to say that a reasonably stable price level has become the accepted definition of good money, and that, as long as the central bank delivers an acceptable degree of price-level stability, it must have done a good job. Price level here means any of the broad-based statistical averages of prices in the economy that are considered reasonable representations of money’s purchasing power, such as, most important, the consumer price index, and sometimes the producer price index and potentially others. In today’s debate, a reasonably stable price index has become shorthand for monetary stability. This is not a new idea but has been deeply engrained in neoclassical economics. In his 1931 book Prices and Production, which provides an excellent exposition of the Austrian Business Cycle Theory, Hayek quotes Cambridge economist Arthur C. Pigou as saying that “if countries with paper currencies will regulate them with a view to keeping the general price level in some sense stable, there will be no impulses from the side of money which can properly be called ‘autonomous.’ ”1
eBook - PDF- Rhona C. Free(Author)
- 2010(Publication Date)
- SAGE Publications, Inc(Publisher)
3 0 MACROECONOMIC MODELS CHRISTOPHER J. NIGGLE University of Redlands T he term macroeconomics refers to study of the behavior of an economy as a whole or as a system; the phenomena explained are (1) the short-run level of economic activity—the levels of national output, income, and employment; (2) the causes of short-run fluctuation in economic activity (business cycles); and (3) the long-run growth rate of an economy. This chapter focuses on the first two aspects of macroeconomics. The models are presented in an approximate chronological order; the chapter's organizing theme is that modern macro-economic models can be seen as based on one of two com-peting visions of the economy: (1) The economy is seen as stable, with strong market forces pushing it toward an equilibrium level consistent with full employment of labor and capital (as in the classical and new classical models), or (2) it is seen as an unstable system that grows through time in a boom-bust pattern, with its normal state being less than full employment and so less-than-potential output being produced (as in Keynes's and the Keynesians' models). The Beginning: Keynes's Critique of Classical Economics Macroeconomics as a distinct field within economics emerged in the late 1930s as a response to John Maynard Keynes's General Theory of Employment, Interest and Money (1936/1973, referred to subsequently as GT). Keynes contrasted his views on the causes of depressions and persistent involuntary unemployment with those of his predecessors, whom he termed the classical economists. In Keynes's view, these economists assumed that the normal condition for a market economy is one of capital-accumulation-fueled growth with full employment of labor and capital, and that periods of high unemployment were rare and temporary deviations from the norm.
eBook - PDF- B. Sheehan(Author)
- 2009(Publication Date)
- Palgrave Macmillan(Publisher)
If the money supply falls by 10 per cent, on the same basis, the price-level declines by an equal percentage. 6 In the Treatise Keynes reconsiders the Fisher equation and its significant limitations; the most important being the failure to consider a role for money as a store of value. But once again this is beyond the remit of this chapter though it does form part of the appendix. In the efforts to derive the purchasing power of money both the Cambridge and Fisher versions of the quantity theory do not men- tion the determination of the price of a single commodity (i.e. the Marshallian theory of value). It is as if there is an analytical dichotomy in the classical analysis between the microeconomic determination of the price of a single commodity through the laws of supply and demand (i.e. Marshall’s scissors) and the macroeconomic derivation of 26 Understanding Keynes’ General Theory the general price-level. Keynes caustically notes that when the classical school analyses: the theory of value, they have been accustomed to teach that prices are governed by the conditions of supply and demand; and, in par- ticular, changes in marginal costs and the elasticity of short-period supply have played a prominent part. But when they pass to volume II, or more often in a separate treatise, to the theory of money and prices, we hear no more of these homely but intelligible concepts. (Keynes, 2007, p. 292) This is a result of the methodology of the classical school. The price of a single commodity is determined by one set of forces, the general price- level by another separate set of forces, and the two analytical frameworks are never brought into close connection. It is a position with which Keynes feels uneasy, and he rectifies it in the General Theory model. Using the concept of aggregate effective demand Keynes attempts to bring back the analytical connection between the theories of value and prices as part of a broader general theory (see Chapter 10).
eBook - PDF- Michael Veseth(Author)
- 2014(Publication Date)
- Academic Press(Publisher)
Simplified Classical Economics It is a shame to oversimplify the complex economic theories of Adam Smith, David Ricardo, Thomas Malthus, and Alfred Marshall. Still, in the interest of this discussion, we can collapse the classical view of the macroeconomy into two simple propositions: 1. Markets Clear. Wages and prices are sufficiently flexible for markets laissez faire: a policy of to clear—if they are left alone! A laissez faire economic policy is required. minimum government Government should stay out of markets and let wages and prices be free to interference in market signal consumers and producers. actions. 2. Say's Law Holds. Macroeconomic problems do not exist when markets are allowed to do their job. Production creates income sufficient to purchase all goods made. Say's Law guarantees that no persistent surplus of goods exists, just as the first proposition assures us that no persistent surplus of any indi-vidual good is possible. The appropriate government policy, given these two propositions, is hands off! The Keynesian Response The fact of the Great Depression refutes the propositions presented above. Markets clearly do not clear. Are the long unemployment lines of 1932 (and 1982!) indicators of labor market equilibrium? The classic view is flawed in two ways. First, wages and prices are not as flexible as economists might like to think. Wages and prices are sticky and do not fall far enough to eliminate surpluses. Since supply does not adjust to surpluses by cutting price, the demand side of the market must be helped by government. Say's Law of Markets does not apply, either. Production of $1 worth of bread does make $1 income for bread workers and bakery owners, but there is no guarantee that anyone wants to spend that dollar. Workers might save it SUMMARY 139 and investors refuse to use it for new projects. Falling spending and income eventually drive down income and saving until a new macroeconomic equilib-rium is reached.
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