Macroeconomics

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MACRO LECTURE 1

NEOCLASSICAL ECONOMICS-

building on the pioneering work of Adam Smith(1723-1790)(the father of modern economics), neoclassical economics of the early 1900s were built on 3 core theoretical beliefs.These were;

Marginal productivity theory of distribution

markets always clear

Say's law

Led themto conclude that a "LAISSEZ FAIRE" approach is most suitable for managing the economy. This position was always preferable to government intervention.

Marginal productivity theory of distribution:

ASSUMPTION 1; No power balances and no exploitative relationships exist.

All markets are assumed competitive(i.e. workers have multiple employers trying to hire them and employers have multiple workers to choose from.)Employers and workers are considered to have equal bargaining power.

Under these conditions, workers will get paid what they are worth depending on their productivity.A productive worker with a high marginal productivity will be more sought after and will earn a higher wage and vica versa.

ASSUMPTION 2: Theory assumes everyone has the same access to education and oppurtunities- it ignores social class and tother "connections"

IF THE STATED ASSUMPTIONS HOLD,THEN THE THEORY IMPLIES THAT THE GOVERNMENT SHOULD NEVER INTERVENE TO REDUCE INEQUALITY AS THIS WOULD MEAN TRANSFERRING MONEY FROM HIGHLY PRODUCTIVE PEOPLE TO LESS PRODUCTIVE PEOPLE.

Attempts at redistribrution would lead to a less productive economy were considered a disicentive for workers and producers.

In the US in the 1920s,despite widening inequality, no attempt was made to reduce income inequality.

2:

"The neoclassical theory that supply always equals demand in all markets, so the invisible hand of the market always allocates resources efficiently.

Idea that all markets are competitive and there are no barriers to entry-prices will therefore always adjust to any shortage or surplus. If there is a surplus of goods, prices will fall and consumers will purchase more of them

The same logic applies to workers-unemployment(i.e. a surplus of labour), dissapears when wages fall as firms will hire more workers etc.

Unemployment considered only to exist when workers demand higher wages than they are entitled to

CAPITALIST MARKETS; Ideal,rational and efficient at allocating resources.No intervention needed in the economy to help unemployed or girms.

SAY'S LAW:

"Law of markets"

SUPPLY CREATES IT's OWN DEMAND, AND SAVINGs IS EQUAL INVESTMENT

"Supply creates it's own demand"= Idea that the very act of supplying products, firms creates incomes.

A firms revenues provides income for workers,suppliers and owners.> tihs income is then used to purchase all the goods producers

Any income that is saved will automatically be invested.Banks then lend it on at afforable rates in order to make a profit. Even if pessimistic consumers save more> banks will lend at a lower rate and this stimulates investment? income returned to economy via circular flow.

ALWAYS EXACTLY ENOUGH DEMAND TO PURCHASE ALL OF THE GOODS THAT ARE SUPPLIED.

"Savings always equals investment"

Firms pay;

Wages to workers hired in labour markets

Rent to landlords in real estate markets

Interest to banks

Dividends to owner of capital in financial markets

Households recieve income and they either;

- Spend it on goods and services

- Put it in banks as savings

Money placed in banks is then either loaned to firms(capital goods) or to consumers to purchase consumer durables- both are considered investment spending.

ALL MONEY IS SAVED IS RETURNED TO THE ECONOMY VIA INVESTMENT SPENDING.

Keynes "theoretical revolution"-

Developed his key ideas bsed on actual investor and worker behaviours

core contrbrutions to economic theory;

Recognised the volatility of investment

Sticky wages and prices

Problems caused by wage and price deflation

The multiplier

VOLATILITY OF INVESTMENT;

Keynes believed that capital spending(investment) was dependent on expected future sales(and profits). These expectations can vary dramatically- ;eading to booms and busts in the business cycle

Argued that Says Law did not incorporate this fundimental driver of investor behaviiour

1929 Wall ST crash; According to Says Law, the loss in consumer confidence would see a decrease in spending and an increase in saving.Banks would have more money to lend and reduce interest rates

BUT THIS DID NOT HAPPEN- KEYNES ARGUED THIS WAS BECAUSE EXPECTED SALES WERE LOW. COMBIATION OF FALLING CONSUMER SPENDING AND RISING UNEMPLOYMENT MEANT BUSINESSPEOPLE WOULD NOT INVEST

^ Expectations have a KEY role in driving investment

During the great depression,unemployment increased and consumer spending fell. Even though interest rates were low, business dramatically cut investment spending.

If Says Law was correct, investment spending woul have increased as interest rates were low.THIS DID NOT HAPPEN

- Savings continued to exceed investment

- Situation was made worse by failing banks

STICKY WAGES AND PRICES:

Keynes observed that labour markets did not clear in the way Neoclassical economits had predicted after the 1929 crash

wages= Workers and unions resisted wage cuts.This led to wage strikes and lower productivity,further damaged profits. Employers found they could cut jobs more easily than cut wages. In tihs sense, Keynes observed that wahes were "sticky downwards"

Wages increased during booms because employers compete for workers. Wages take much longer to fall during recessions.

Prices; Prices of goods would eventually fall(i.e. by 20% 1930-1933).However, the fall in prices did not result in an increase n consumer purchases as Neoclassical theory would have predicted.

LABOUR MARKETS DO NOT CLEAR<WAGES "STIKY DOWNWARDS"