MACROECONOMICS ASSIGNMENT
RESUME OF CLASSIC AND MODERN THEORY
ARRANGED BY :
NANDIAS ALFIANA ROSI
1610631030191
FACULTY OF ECONOMICS AND BUSINESS
UNIVERSITY OF SINGAPERBANGSA KARAWANG
2016
LIST OF CONTENT
List of Content
Preface
BAB I : INTRODUCTION
Definition of Classic Economics
Definition of Modern Economics
Definition of Keynesian Theory
BAB II : EXPLANATION
Differences Between Classic And Modern Theory
BAB 3 : CLOSING
Bibliography
Preface
Assalamualaikum wr.wb
First of all, i wanna say thank you for Allah to give me a chance to keep breathing untill now and for all blesses here,also, thanks to my parent, my partner and all my friends. Special thanks for Mr. Irvan Yoga Pardistya,SE,MM to give me this exercises.
All of the things that we know when i'm doing this exercise isnt easy, i hope that all of my answers can useful and helpful for another people out of here.
Wassalamualaikum wr.wb.
Karawang, 9th October 2016
Nandias Alfiana Rosi
CLASSICAL ECONOMICS
Adam Smith's The Wealth of Nations in 1776 is usually considered to mark the beginning of classical economics.[2] The fundamental message in Smith's influential book was that the wealth of nations was based not on gold but on trade: That when two parties freely agree to exchange things of value, because both see a profit in the exchange, total wealth increases. Classical economics originally differed from modern libertarian economics in seeing a role for the state in providing for the common good. Smith acknowledged that there were areas
where the market is not the best way to serve the public good, education being one example, and he took it as a given that the greater proportion of the costs of these public goods should be borne by those best able to afford them.
Classical economists observe that markets generally regulate themselves, when free of coercion. Adam Smith referred to this as a metaphorical "invisible hand," which refers to the notion that private incentives are aligned with society welfare maximization under certain competitive conditions. Smith warned repeatedly of the dangers of monopoly, and stressed the importance of competition.
There is some debate about what is covered by the term "classical economics", particularly when dealing with the period from 1830–75, and how classical economics relates to Neoclassical economics. In more recent times, those economists who see major flaws with the heavy theoretical basis of mainstream economics have looked to classical economics for what they consider a more realistic perspective. They praise classical economics as being more understandable to the average citizen than theoretical economics (citation needed).
In contrast to classical economics, Keynesian economics supports such as, control of
the money supply, and a graduated income tax to counter recession and income inequality. Most classical economists reject these ideas. They assert that state intervention makes recessions worse. Unlike mainstream economics, they blame the Great Recession on government interference in the economy.
Classical economics assumes flexible prices both for goods and wages and predicts that supply can create its own demand – in other words, that production will generate enough income to allow its own products to be purchased. The Model T Ford serves as real-world example of this idea, which can be generalized when the goods being produced are affordable and have a clear benefit to the buyer.
Many classical economists also believe in a gold standard. and believe that the pervasive use of fiat money explains why classical economics has not worked in the short term.
Classical economists blame the government for the Great Recession. They point to plans such as debt cancellation and taxing consumption instead of production as solutions to our economic problems.
According to Say’s law, supply creates its own demand. Excess income (savings) should be matched by an equal amount of investment by business. Interest rates, wages and prices should be flexible. The classical economists believe that the market is always clear because price would adjust through the interactions of supply and demand. Since the market is self-regulating, there is no need to intervene.
MODERN ECONOMICS
A country's economic growth may be defined as a long-term rise in capacity to supply increasingly diverse economic goods to its population, this growing capacity based on advancing technology and the institutional and ideological adjustments that it demands. All three components of the definition are important. The sustained rise in the supply of goods is the result of economic growth, by which it is identified. Some small countries can provide increasing income to their populations because they happen to possess a resource (minerals, location, etc.) exploitable by more developed nations, that yields a large and increasing rent. Despite intriguing analytical problems that these few fortunate countries raise, we are interested here only in the nations that derive abundance by using advanced contemporary technology - not by selling fortuitous gifts of nature to others. Advancing technology is thepermissive source of economic growth, but it is only a potential, a necessary condition, in itself not sufficient.
If technology is to be employed efficiently and widely, and, indeed, if its own progress is to be stimulated by such use, institutional and ideological adjustments must be made to effect the proper use of innovations generated by the advancing stock of human knowledge.
To cite examples from modern economic growth: steam and electric power and the large-scale plants needed to exploit them are not compatible with family enterprise, illiteracy, or slavery - all of which prevailed in earlier times over much of even the developed world, and had to be replaced by more appropriate institutions and social views. Nor is modern technology compatible with the rural mode of life, the large and extended family pattern, and veneration of undisturbed nature.
The source of technological progress, the particular production sectors that it affected most, and the pace at which it and economic growth advanced, differed over centuries and among regions of the world; and so did the institutional and ideological adjustments in their interplay with the technological changes introduced into and diffused through the growing economies. The major breakthroughs in the advance of human knowledge, those that constituted dominant sources of sustained growth over long periods and spread to a substantial part of the world, may be termed epochal innovations. And the changing course of economic history can perhaps be subdivided into economic epochs, each identified by the epochal innovation with the distinctive characteristics of growth that it generated. Without considering the feasibility of identifying and dating such economic epochs, we may proceed on the working assumption that modern economic growth represents such a distinct epoch - growth dating back to the late eighteenth century and limited (except in significant partial effects) to economically developed countries.
These countries, so classified because they have managed to take adequate advantage of the potential of modern technology, include most of Europe, the overseas offshoots of Western Europe, and Japan - barely one quarter of world population. Limitations of space prevent the presentation of a documented summary of the quantitative characteristics commonly observed in the growth of the presently developed countries, characteristics different from those of economic growth in earlier epochs. However, some of them are listed, because they contribute to our understanding of the distinctive problems of economic life in the world today. While the list is selective and is open to charges of omission, it includes those observed and empirically testable characteristics that lead back to some basic factors and conditions, which can only be glimpsed and conjectured, and forward to some implications that have so far eluded measurement.
KEYNESIAN ECONOMICS
The great depression is 1930s seemed to refute the classical idea that markets were self-correcting and should provide full employment. Keynes provided some explanations: 1) savings and investments are not always equal; 2) producers may lower output instead of prices to reduce inventories; 3) Lower production may increase unemployment rate and decrease incomes; 4) monopoly power on the part of producers and labor unions would prevent prices and wages to adjust downward freely. According to Keynes’ theory, wages and prices are not flexible. Rigid price will give a horizontal AS curve in the short run.
DIFFERENCES BETWEEN CLASSICAL ECONOMICS AND MODERN ECONOMICS BY KEYNESIAN THEORY
1. Shape of long run aggregate supply.
The most basic distinction between the Keynesian and classical view of macroeconomics, can be illustrated looking at the long run aggregate supply.
The Classical view is that Long Run Aggregate Supply (LRAS) is inelastic.
Classical view of Long Run Aggregate Supply
This has important implications. The classical view suggests that Real GDP is determined by supply side factors – the level of investment, the level of capital and the productivity of labour e.t.c. Classical economists suggest that in the long-term an increase in aggregate demand (faster than growth in LRAS) will just cause inflation.
Keynesian view of Long Run Aggregate Supply
The Keynesian view of long run aggregate supply is different. They argue that the economy can be below full capacity in the long term.
Therefore, a Keynesian plays greater emphasis on the role of aggregate demand in causing and overcoming a recession.
2. Demand Deficient Unemployment
Because of the different opinions about the shape of the aggregate supply and the role of aggregate demand in influencing economic growth, there are different views about the cause of unemployment
Classical economists argue that unemployment is caused by supply side factors – real wage unemployment, frictional unemployment and structural factors. They downplay the role of demand deficient unemployment.
Keynesians place a greater emphasis on demand deficient unemployment. For example the current situation in Europe (2014), a Keynesian would say that this unemployment is partly due to insufficient economic growth and low growth of aggregate demand (AD)
3. Phillips Curve Trade Off
A classical view would reject the long run trade off between unemployment, suggested by the Phillips Curve.
Classical economists say that in the short term, you might be able to reduce unemployment below the natural rate by increasing AD. But, in the long-term, when wages adjust, unemployment will return to the natural rate, and there will be higher inflation. Therefore, there is no trade off in the long-run
Keynesians support the idea that there can be a trade off between unemployment and inflation. See: Phillips curve
4. Flexibility of prices and wages
In the classical model, there is an assumption that prices and wages are flexible, and in the long-term markets will be efficient and clear. For example, suppose there was a fall in aggregate demand, in the classical model, this fall in demand for labour would cause a fall in wages. This decline in wages would ensure that full employment was maintained and markets ‘clear’.
A fall in demand for labour would cause wages to fall from W1 to W2
However, Keynesians argue that in the real world, wages are often inflexible. In particular, wages are ‘sticky downwards’. Workers resist nominal wage cuts. For example, if there was a fall in demand for labour, trade unions would reject nominal wage cuts, therefore, in the Keynesian model it is easier for labour markets to have disequilibrium.Wages would stay at W1, and unemployment would result.
A Keynesian would argue in this situation, the best solution is to increase aggregate demand. In a recession, if the government did force lower wages, this might be counter-productive because lower wages would lead to lower spending and a further fall in aggregate demand.
5. Rationality and confidence
Another difference behind the theories is different believes about the rationality of people
Classical economics assumes that people are rational and not subject to large swings in confidence.
Keynesian economics suggests that in difficult times, the confidence of businessmen and consumers can collapse – causing a much larger fall in demand and investment. This fall in confidence can cause a rapid rise in saving and fall in investment and it can last a long time – without some change in policy.
Difference in policy recommendations
6. Government spending
The classical model is often termed ‘laissez faire’ because there is little need for the government to intervene in managing the economy.
The Keynesian model makes a case for greater levels of government intervention, especially in a recession when there is a need for government spending to offset the fall in private sector investment. (Keynesian economics is a justification for the ‘New Deal’ programmes of the 1930s.)
7. Fiscal Policy
Classical economics places little emphasis on the use of fiscal policy to manage aggregate demand. Classical theory is the basis for Monetarism, which only concentrates on managing money supply, through monetary policy.
Keynesian economics suggests governments need to use fiscal policy, especially in a recession. (This is an argument to reject austerity policies of 2008-13 recession.
8. Government borrowing.
A classical view will stress the importance of reducing government borrowing and balancing the budget, because there is no benefit from higher government spending.
Lower taxes will increase economic efficiency. (e.g. at the start of the 1930s, the ‘Treasury View‘ argued the UK needed to balance its budget by cutting unemployment benefits.
The Keynesian view suggests that government borrowing may be necessary because it helps to increase overall aggregate demand.
9. Supply Side Policies
The classical view suggests the most important thing is enabling the free market to operate. This may involve reducing the power of trade unions to prevent wage inflexibility. Classical economics is the parent of ‘supply side economics‘ – which emphasises the role of supply side policies in promoting long term economic growth.
Keynesian don’t reject supply side policies. They just say they may not always be enough. e.g. in a deep recession, supply side policies can’t deal with the fundamental problem of a lack of demand.
BIBLIOGRAPHY
https://en.wikipedia.org/wiki/Classical_economics
http://www.economicshelp.org/keynesian-vs-classical-models-and-policies/
http://smallbusiness.chron.com/differences-between-classical-keynesian-economics-3897.html
Mukherjee, Sampat. 2002. Modern Economic Theory. New Delhi : New Age International.
Eckhard Hein and Engelbert Stockhammer. 2011. A Modern Guide to Keynesian Macroeconomics and Economic Policies. Edwan Elgar Publishing.
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