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Course: Macroeconomics > Unit 7
Lesson 4: Keynesian economics and its critiques- Keynesian economics
- Risks of Keynesian thinking
- Macroeconomic perspectives on demand and supply
- Keynes’ Law and Say’s Law in the AD/AS model
- Aggregate demand in Keynesian analysis
- The building blocks of Keynesian analysis
- The Phillips curve in the Keynesian perspective
- The Keynesian perspective on market forces
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Keynesian economics
Contrasting Keynesian and Classical Thinking. Created by Sal Khan.
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- This is sort of an oddball question, but Sal's proposed idealized model around11:00or so got me thinking - would it be possible to design an economic system designed to respond semi-autonomously? Instead of having one MO, is there a downside to setting up so that, say, when it gets past a certain point (too far to the left on his diagram) pre-determined Keynesian policies kick in, and too far to the right gov't purchases are shut off to hold down inflation?(42 votes)
- The progressive income tax is designed to automatically help stabilize the economy. During periods of recession when incomes are low, the tax rate is low to increase disposable income and thus increase consumption and AD. During periods of inflation when incomes are high, tax rates increase to help lower consumption and shift AD to the left.(35 votes)
- is classical the same as the austrian school of thought?(11 votes)
- Confusingly, Keynes inaccurately uses the term 'Classical' to refer to both the 'Classical economics' of Smith, Ricard, Say and Mill; as well as 'Neoclassical economics', the supply and demand theory which forms so-called 'mainstream economics'. The Austrian School of Thought is distinct from both of these, and does not fall into Keynes' definition of 'Classical'.(15 votes)
- what would a classical economist implement to move out of recession ?(7 votes)
- Nothing! One of the major problems of a recession is unemployment, and a classical economist would believe that eventually, assuming wages aren't sticky, workers would accept lower wages, employment would increase, and SRAS would move back to the right.(10 votes)
- Does the claim that war can create wealth and jobs come from a Keynesian school of thought?(7 votes)
- Indeed it does. This theory holds that increased government spending (which war, particularly of the "total" flavor, causes) leads to an increase in spending in general, which stimulates the economy. There is a lot of nuance to Keynesian economics, as well as a lot of controversy, but this is a basic explanation.(2 votes)
- Can you follow the thought through as to where the goverment investment comes from and its effect? You seem to have a closed loop system with this outside government influence that has a positive result on the closed loop with no other effects to this system as a whole.(2 votes)
- Theoretically, the government spending comes from things like taxes, which requires the consumers to have money (from working). The investment goes to either/both firms and households, thus stimulating the economy. (As I said this is the theory)
In the real world, however, governments tend to decrease taxes and increase spending, rarely increasing taxes to gain money. This means governments eventually start spending money they do not "have," which of course means that the entire economy will be brought down by lack of sufficient funds and the government will have to borrow money from other governments in order to "bail out" the economy.
Hope that helped.(4 votes)
- Could it be that depressions are caused by central bank policy of easy lending and inflation, which Hayek points to, and that spending in times of crisis prolongs the depression, because it destroys savings and distorts the market, by distorting the price of money (interest rates)?(3 votes)
- That's part of the Austrian Business Cycle Theory. And yes, there have been instances when recessions were caused due to manipulation of interest rates. But you have to know the other theories which also apply in many cases, such as the Monetarist Theory or the Real Business Cycle Theory. Both are also equally applicable in real-life scenarios.(2 votes)
- At05:40, I'm kind of confused as to what is meant by prices being 'sticky'. Clarification would be greatly appreciated; thanks!(3 votes)
- For example, a certain wage being compromised due to an economic condition makes it "sticky;" in other words susceptible to different variables or components of the economy interacting, affecting one another. This is how I understand it.(1 vote)
- Couldn't one argue that Universal Basic Income is a kind of Keynesian concept in the sense that it will create demand among the lower classes? If so, would that be as risky?(3 votes)
- Yes, it would be a Keynesian type policy from that point of view. I think it would be extremely risky though to institute UBI since it would take away motivation for workers. If they get paid the same regardless of the job they do, then they will do a bad/easy job.(1 vote)
- Difference between classical model and classical-Keynesian model?(2 votes)
- The Keynesian model deals only with the short term, while the classical model deals only with the long term. Lord John Maynard Keynes, the founder of Keynesian economics once famously said that "in the long run, we are all dead," showing his contempt for earlier economists. He compared it to a meteorologist always saying that in the long term, the climate will be calm, when we don't actually care about the long term when thinking about the weather.(2 votes)
- Will it be correct to say that the Classical Theory is supply-side economics while the Keynesian Theory is demand-side economics ?(1 vote)
- Yes, in the classical theory people believe that if supply is stimulated, the economy will improve. And when the economy improves, people have more money to spend, so demand will increase too.
The Keynesian theory focuses more in increasing demand, which then turns into the multiplier effect that was explained at7:52.(2 votes)
Video transcript
Voiceover: What I want to do in this video is start introducing and
we've already talked about him a little bit. So actually they've
already been introduced, but maybe flesh out a little
bit more Keynesian thinking. This right here is a picture
of John Maynard Keynes and I often mispronounce him as Keynes, because that's how it's spelled, but it's John Maynard Keynes. He was an economist who did a lot of his most famous work
during the Great Depression, because in his view,
classical models did not seem to be of much use during
the Great Depression. To understand this a little bit better, let's compare purely
classical aggregate supply aggregate demand models to maybe one that's more Keynesian. Some of what we've talked about - Keynesian, I should say. I already did my first mispronunciation. One that's a little bit more Keynesian. Keynesian right over here. In some of the conversations,
we've already begun to introduce a little bit
of Keynesian thinking, but in this video we're going to try to show the difference between the two and it's not to say that one
is right or one is wrong. In fact, Keynesian felt
that in the long run, the classical model actually made sense, but he also famously said, "In the long run we are all dead." I also want to emphasize
that this isn't a defense of Keynesian economics. There are some points
to what he has to say, but there are other schools of thought. Unfortunately, they
often get very dogmatic, but they also have some reasons to be wary of Keynesian economics
and we hope to go over some of that in future videos. In this one, we just want to understand what Keynesian economics is all about and how it really was
a fundamental departure from classical economics. In classical economics, I'm going to use aggregate demand and
aggregate supply in both. This is classical, this is
price, this right over here is real GDP and I'm going to do it for the Keynesian case, as well. This is price and this
right over here is real GDP. In both views of reality, or both models, you have a downward sloping
aggregate demand curve for all the reasons
that we've talked about in multiple videos. That's aggregate demand right over there. We've already seen it,
the classical view is that in the long run, an
economy's productivity, or productive capacity,
or its output shouldn't be dependent on prices. We've seen the long run
aggregate supply curve something like this. This is the aggregate
supply in the long run, or sometimes you'll have
long run aggregate supply. Sometimes it'll be referred to that. Saying, look, all prices
are, they're a way to signal what people want and demand
and things like that, but at the end of the
day, prices and money, they're just facilitating transactions. You go to work and you
get paid and all that, but then you go and use
that money to go and buy other things that the economy produces, like food and shelter and transportation. All money is is a way of
facilitating the transactions, but the economy, in theory,
based on how many people it has, what kind of technology it has, what kind of factories it has, what kind of natural resources
it has, it's just going to produce what it's going to produce. If you were to just
change aggregate demand, if the government were to print money and aggregate demand were to - and just distribute it from helicopters, in this classical model,
you would just have aggregate demand shift to
the right, but you have this vertical long run
aggregate supply curve so the net effect is it
didn't change the output in this classical model. All that happens is that the price goes from this equilibrium price
to this equilibrium price over here. You have the price would go up and you would just experience inflation with no increased output
and there's multiple ways you could've shifted that
aggregate demand curve to the right. You could have a fiscal
policy where the government, maybe it holds its tax revenue constant, but it increases spending, or it goes the other way around. It does not decrease, it
doesn't change its spending, but it lowers tax revenue. Either of those, it tries to
pump money into the economy and pushes that aggregate
demand curve to the right. In this purely classical
view, it says in the long run, that's not going to be any good,
just will lead to inflation. The only way that you
can increase the output of economy is by making
it more productive. Maybe making some
investments in technology, make the economy more efficient, maybe your population grows. The only way is to really
shift this curve to the right on the supply side right over here. Keynes did not disagree with
that, but he sitting here in the middle of the
Great Depression, saying, "Look, all of a sudden
people are poor in the 1930s. "Factories did not get blown
up, people didn't disappear. "In fact, there are
factories that want to run, but they are being shut
down, because no one "is demanding goods from them. "There are people who
want to work, but no one "is asking them to work. "They could work and produce
wealth that could then "be distributed to - "But no one's demanding
for them to do it." He suspected something weird was happening with aggregate demand,
especially in the short run. In a very pure, very,
very short run model, I know we have talked about a short run aggregate supply curve
that is upward sloping. Something that might
look something like that. That is actually starting to put some of the Keynesian ideas into practice. What I like to think of
is something in between, but if you think in the
very, very, very short term, Keynes would say prices are
going to be very sticky. Especially in the short
run, and I'll call it the very short run, you have, especially if the economy's
producing well below its capacity, like it seemed to be doing during the Great Depression,
prices are sticky. That makes intuitive sense. If the economy's trying to get overheated, people are being overworked, you want them to work more, hey, I want overtime. You want factories to operate
faster, people are going to start - The utilization is high, people
are going to start charging more and more, but if I'm
unemployed and I'm desperate to work, I'm not going
to ask for a pay raise. If my factory is at 30%
utilization and someone wants to buy a little bit more, that's
not the time that I'm going to say, "Hey, I'm going
to raise prices on you." I'll say, "Yeah, exact same price. "You want another 5% of
my factory to be utilized? "Sure, that sounds great." In the very short run,
it has the opposite view of the aggregate supply curve
than the classical model. It says at any level of
GDP in the short run, prices won't be affected. It won't be affected. So in this model right over
here, this is aggregate supply I'll call it, in the very short run. You can debate what short
run or very short run means, whether we're talking
about days, weeks, months, or even a few years here,
but once you start looking at the world this way, then something interesting happens. In this model right over
here, the only way to increase GDP was on the supply side. In this model right over
here, the only way to increase GDP is on the demand
side, to actually either through monetary policy, print more money, or through fiscal policy, lower taxes while holding spending
constant or maybe do both, essentially deficit spending. Someway, without holding taxes constant, but the government's
spending more, whatever. Shift the curve to the right
and that might be a way to increase the overall output. Keynes' real realization was that, look, the classical economist
would tell you if you have a free and unfettered market,
the economy will just get to its natural, very efficient state. Keynes says, "Yes, that is sometimes true, "but that's sometimes not true." We'll talk about different cases. By no means do I think the Keynesian model is the ideal and I don't think even Keynes would have thought the Keynesian model describes everything. Depends on the circumstance. Keynes would say, "Look, let's think "of a very simple idea." You have person A, person
B, person C, and person D. Let's say person A sells
to person B, person B sells to person C, person C sells to person D, and person D sells to person A. Let's say that they're
all selling two units of whatever good and
service that they offer. For whatever reason, let's
say C, all of a sudden, just got a little bit
pessimistic, had a bad dream, woke up on the wrong
side of the bed and says, "You know what? "I'm not feeling so
good about the economy. "I'm going to hold off
from my purchase from B. Instead of two units, I'm
going to purchase one unit. Well, B says, "Well,
gee, my business is bad. "Now I'm only going to purchase one unit." A does the same thing for the same reason, D does the same thing. Now it all came back to C and now C says, "Wow, I was right, that
dream was predictive." It was a self-fulfilling prophecy. Now they're going to operate in this state and there might not be any
natural way to get them bumped up to that state
where they're all buying two units from each other
without maybe some outside, especially some government act or maybe all of a sudden saying, "Hey B, if C doesn't want
to buy two, I'm going "to buy two temporarily." There are dangers to this, huge dangers, and we'll talk about
that in future videos, but then someone else,
let's say the government, tries to shift the aggregate demand curve through fiscal policy and they say, "Hey, I'll buy one from you, B." Then B says, "Okay, now
I can buy two again," and A can buy two again and
then D can buy two again and then C can buy two again. Then in an ideal world,
and this is the danger of the government, the
government would step back and say, "Okay, everything is fine again. "I don't have to buy this." As we know, it's very
hard once the government starts spending money in
some way, to actually cut this spending right over here. This was the general
idea behind the Keynesian versus the classical. He says, "Look, there are circumstances, "like the Great Depression,
where the economy "is operating well below its potential "and in those circumstances,
you need to have "a stimulus on the demand
side, not just a supply side." The correct answer, as with all things, is probably something in between. A probably more accurate
model is something like this. Let's draw ... This is price, this is
real GDP right over here and we'll still draw our downward sloping aggregate demand curve and
the more accurate thing might look something like this. Let's say that this is the absolute theoretical maximum output,
if everyone in the country isn't sleeping, the
factories are just being run to the ground, that's the
absolute theoretical output. Let's say that this is its potential. Just a healthy state where the economy might be operating. The real medium run
supply curve or short run aggregate supply curve. This is aggregate supply
in the very long run. This is the long run aggregate supply. The best model would be
something that's in between and might look something like this. Our aggregate supply curve
might look something like - I want to do it in a different color. Let me do it in magenta. It might look something like this. For whatever reason, maybe
someone has a bad dream or a bunch of people have a bad dream or something scary
happens, aggregate demand - The stock market crashes,
something happens, aggregate demand shifts over there. When we're out here, now all of a sudden our output is well below
potential, we have a lot of excess capacity and now
the Keynesian ideas seem maybe they'll make sense. Maybe there should be some outside stimulus happening. On the other side, if we're
performing well at potential, then all of a sudden the
government wants to do Keynesian policies and
we'll see in future videos, the government will always want to do Keynesian policies,
even if they're not justified. It will push aggregate demand out here and then the net effect is, especially the more
vertical this is, the more this net effect will be true,
that you really just get more inflation and you
don't really get a lot of increase in output. It really depends on the circumstance, but an aggregate supply
curve that starts flat at low levels of output
and then gets higher and higher slope and
becomes almost vertical in your high levels of
output, this is probably a better model that
takes into consideration both the classical and
the Keynesian ideas.