Keynesian and Neoclassical Economics Flashcards
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Questions and Answers

What is potential GDP?

The level of GDP that an economy can sustain over the long term without leading to inflation.

In the long run, real GDP will be close to or on what part of the AS curve?

The vertical part of the AS curve.

If real GDP is greater than potential GDP, what occurs?

The unemployment rate is low and the price level is rising.

If real GDP is close to or at potential GDP, then ________ and if real GDP is much lower than potential GDP, then ________.

<p>equilibrium occurs in the steep range of AS; equilibrium occurs in the flat range of AS.</p> Signup and view all the answers

Which correctly describes the Aggregate Demand-Aggregate Supply model?

<p>The price level is shown on the vertical axis.</p> Signup and view all the answers

Aggregate demand represents total spending on ________.

<p>a nation's domestic output of goods and services.</p> Signup and view all the answers

On the far left side of the AS curve, the economy is producing ________ potential, and on the far right of the curve, it is producing ________ potential.

<p>below; above.</p> Signup and view all the answers

Using the aggregate demand (AD)-aggregate supply (AS) model, macro equilibrium occurs where?

<p>The AD and AS are equal.</p> Signup and view all the answers

What does Keynesian economics argue is the cause of recessions?

<p>insufficient aggregate demand</p> Signup and view all the answers

According to Keynes, a variety of factors affect consumption expenditure including ________.

<p>disposable income and consumer confidence</p> Signup and view all the answers

Why is business investment considered the most volatile component of aggregate demand according to Keynes?

<p>it is closely tied to confidence and expectations</p> Signup and view all the answers

What action does the Keynesian perspective suggest if the government cuts taxes and increases spending during a recession?

<p>increase aggregate demand</p> Signup and view all the answers

Since aggregate demand is defined as spending on domestic goods and services, then an increase in U.S. imports would ________ aggregate demand.

<p>subtract from</p> Signup and view all the answers

Which statement aligns with Say's Law during a recession?

<p>An effective stimulant for a recessionary economy is providing subsidies for investors.</p> Signup and view all the answers

What happens when aggregate demand increases in the neoclassical zone, where supply is at its potential GDP?

<p>The aggregate price level increases as AD shifts to the right</p> Signup and view all the answers

In the neoclassical zone, what effect do shifts of the AD curve have on GDP?

<p>little to no effect because the LRAS is at potential</p> Signup and view all the answers

How does a leftward shift in AD relate to Keynes' law in the intermediate zone?

<p>As AD shifts left to a flatter part of the AS curve, GDP decreases</p> Signup and view all the answers

What area do both Keynesian and Neoclassical economics agree upon related to aggregate demand?

<p>Aggregate demand is a useful tool for controlling inflation</p> Signup and view all the answers

What is the state of the economy when prices are sticky and output can grow without inflationary pressures?

<p>Keynesian Zone</p> Signup and view all the answers

What is the shape of the intermediate zone of the AS curve?

<p>upward-sloping</p> Signup and view all the answers

What does disposable income refer to?

<p>income after taxes</p> Signup and view all the answers

What does inflationary gap refer to?

<p>equilibrium at a level of output above potential GDP</p> Signup and view all the answers

What is meant by interest rate?

<p>the payment for borrowed money</p> Signup and view all the answers

What is recessionary gap?

<p>equilibrium at a level of output below potential GDP</p> Signup and view all the answers

According to Keynesian economics, recessions happen when aggregate demand falls below ________ and ________.

<p>full employment; potential GDP</p> Signup and view all the answers

What kind of intervention would NOT involve the government or the federal reserve according to Keynes?

<p>Adjustment of sticky wages and prices</p> Signup and view all the answers

When the aggregate supply curve is flatter than the market supply curve for labor or goods and services, this is an example of a(n) ________.

<p>macroeconomic externality</p> Signup and view all the answers

What is a principle assumption of the Keynesian economic framework?

<p>prices and wages are sticky and do not adjust rapidly to changes in aggregate demand</p> Signup and view all the answers

During recessionary times, it can be hard to coordinate lower wages for workers because of the ________.

<p>coordination argument</p> Signup and view all the answers

If prices change frequently, this cost is called ________.

<p>menu cost</p> Signup and view all the answers

Which statement best represents the Keynesian Perspective?

<p>People's demand determines what is built</p> Signup and view all the answers

According to the Keynesian perspective, the government ________ play a role in managing the macroeconomy ________.

<p>should; when the aggregate equilibrium does not match potential output</p> Signup and view all the answers

What does a Keynesian analysis of economics assume?

<p>Some prices and wages are sticky</p> Signup and view all the answers

What might Keynesian economists predict happened after the housing market crash in 2007?

<p>a decrease in consumption expenditure, as household wealth declined</p> Signup and view all the answers

The cost of updating prices at which a business sells their goods is called ________.

<p>menu costs</p> Signup and view all the answers

Which of the following is NOT considered a type of business investment expenditure?

<p>Stocks and bonds</p> Signup and view all the answers

What does the coordination argument refer to?

<p>downward wage and price flexibility requires perfect information about the level of lower compensation acceptable to other laborers and market participants</p> Signup and view all the answers

What is the expenditure multiplier?

<p>Keynesian concept that asserts a change in autonomous spending causes a more than proportionate change in real GDP</p> Signup and view all the answers

What is a macroeconomic externality?

<p>occurs when what happens at the macro level is different from and inferior to what happens at the micro level</p> Signup and view all the answers

What are menu costs?

<p>costs firms face in changing prices</p> Signup and view all the answers

What does sticky wages and prices refer to?

<p>a situation where wages and prices do not fall in response to a decrease in demand</p> Signup and view all the answers

What kind of recession would a small multiplier effect likely lead to?

<p>Less severe</p> Signup and view all the answers

When considering the spending multiplier, which of the following statements is not true?

<p>The spending multiplier gets bigger as the MPS rises</p> Signup and view all the answers

What does the Expenditure (or Spending) Multiplier represent?

<p>the ratio of the change in GDP to the change in aggregate expenditure which caused the change in GDP</p> Signup and view all the answers

What is the Marginal Propensity to Consume?

<p>percentage of an increase (or decrease) in income which one spends</p> Signup and view all the answers

What is the Marginal Propensity to Import?

<p>percentage of an increase (or decrease) in income which one spends on imported goods and services</p> Signup and view all the answers

What is the Marginal Propensity to Save?

<p>percentage of an increase (or decrease) in income which one saves</p> Signup and view all the answers

How can an economy operating under Say's law be described?

<p>supply-driven</p> Signup and view all the answers

What does the neoclassical view suggest happens in the case of a recession?

<p>the economy tends to self-correct and return to potential GDP</p> Signup and view all the answers

What type of economic viewpoint puts an emphasis on long-run economic performance?

<p>Neoclassical</p> Signup and view all the answers

If aggregate supply is vertical, what does this imply about the long run?

<p>Aggregate demand does not affect the quantity of output</p> Signup and view all the answers

Why do Neoclassical economists focus more on long-term growth than on fighting recession?

<p>Because recessions are short-lived and the economy is self-adjusting</p> Signup and view all the answers

According to neoclassical thinking, what would increase the output of the country of Zambezi?

<p>Zambezi has technological breakthroughs or improvements</p> Signup and view all the answers

What should the government focus on according to the neoclassical viewpoint?

<p>long-term growth</p> Signup and view all the answers

Which of the following is an example of Say's law?

<p>All that is produced in an economy will be purchased thanks to price adjustment and flexibility</p> Signup and view all the answers

What does Say's Law state?

<p>is widely held to be more accurate in the long run rather than the short term</p> Signup and view all the answers

What do Neoclassical economists argue about the long-run aggregate supply curve?

<p>is vertical</p> Signup and view all the answers

What would a major technological advancement shift according to Neoclassical economists?

<p>potential GDP, or LRAS, to the right</p> Signup and view all the answers

If someone says, 'If you build (produce) it they will come (purchase)', what economic law does this describe?

<p>Say's Law</p> Signup and view all the answers

What is classical economics?

<p>earliest of a number of neoclassical perspectives</p> Signup and view all the answers

What does neoclassical economics encompass?

<p>any of a number of economic perspectives that believes that the macro economy is inherently stable</p> Signup and view all the answers

If an earthquake destroyed half the capital stock of a country, what would happen to its potential GDP?

<p>It would fall temporarily then return to pre-earthquake levels</p> Signup and view all the answers

What must an economy operating at its maximum potential level of output do to improve its living standards?

<p>technology improves</p> Signup and view all the answers

What does the neoclassical long-run aggregate supply curve imply about wages and prices?

<p>completely flexible</p> Signup and view all the answers

Why is the neoclassical long-run aggregate supply curve vertical at the potential level of output?

<p>wages and prices adjust quickly to changes in demand</p> Signup and view all the answers

What is human capital?

<p>education, training and skills possessed by workers that make them more productive</p> Signup and view all the answers

What does natural rate of unemployment refer to?

<p>Rate that unemployment returns to in the long run, where there is no cyclical unemployment</p> Signup and view all the answers

How does the neoclassical perspective define the level of economic activity?

<p>determined primarily by aggregate supply</p> Signup and view all the answers

What is physical capital per person?

<p>the amount and kind of machinery and equipment available to help a person produce a good or service</p> Signup and view all the answers

What is potential GDP?

<p>level of output that can be achieved when all resources are fully employed</p> Signup and view all the answers

What does the neoclassical long-run aggregate supply curve imply about the relationship between aggregate prices and wages?

<p>positive</p> Signup and view all the answers

What do Neoclassical economists believe about expansionary fiscal policy?

<p>not effective and/or not useful</p> Signup and view all the answers

What would the owner of a firm do when anticipating increased demand?

<p>immediately raise prices but not output</p> Signup and view all the answers

What does it mean when a firm exhibits adaptive expectations?

<p>the theory that people look at past experience and gradually adapt their beliefs</p> Signup and view all the answers

What do rational expectations refer to?

<p>the theory that people form the most accurate expectations about the future using all information available to them</p> Signup and view all the answers

Which government policy could be described as a Keynesian response to a recession?

<p>Borrow from the public to finance increased spending on social welfare programs</p> Signup and view all the answers

Which government policy could be described as a neoclassical response to a recession?

<p>Abolish labor unions</p> Signup and view all the answers

Which policy response to a recession is most consistent with Say's Law?

<p>Provide subsidies for investment</p> Signup and view all the answers

Which statement is most consistent with Keynes' Law?

<p>Recessions are caused by a negative 'shock' to aggregate demand</p> Signup and view all the answers

What does the vertical, long-run aggregate supply curve indicate?

<p>the long-run level of economic output is dependent upon productive factors</p> Signup and view all the answers

What can be expected in Canada’s economy from a neoclassical perspective during a labor shortage due to increased demand?

<p>Over the long term, wages and prices will rise but GDP remains at potential</p> Signup and view all the answers

Which government policy is viewed as a neoclassical response to a recession?

<p>Reducing the power of labor unions</p> Signup and view all the answers

What happens to price level when aggregate demand increases according to neoclassical theory?

<p>The price level will rise and the economy will adjust back to equilibrium at potential GDP</p> Signup and view all the answers

In the neoclassical model, what causes the AS curve to shift to the right over time?

<p>productivity increases</p> Signup and view all the answers

Which scenario is viewed as undermining long-run productivity growth from a neoclassical perspective?

<p>stimulus spending by the government</p> Signup and view all the answers

Why can't expansionary fiscal policy raise equilibrium output in the long run according to the neoclassical view?

<p>flexible prices will eventually choke off any increase in aggregate demand</p> Signup and view all the answers

What policies should a neoclassical economist promote to foster a healthy economy?

<p>The government should keep inflation low and maintain low tax levels over the long run</p> Signup and view all the answers

Which factor does not shift the aggregate demand curve?

<p>an increase in the price level</p> Signup and view all the answers

If change in economic agents' expectations is immediate, how does it affect monetary or fiscal policy?

<p>prevents</p> Signup and view all the answers

What does Keynes' law state?

<p>'demand creates its own supply'</p> Signup and view all the answers

What does Say's Law say?

<p>'supply creates its own demand'</p> Signup and view all the answers

How do neoclassical economists generally emphasize the importance of the economy?

<p>importance of aggregate supply in determining the size of the macroeconomy over the long run</p> Signup and view all the answers

In the neoclassical zone of the aggregate supply curve, what characteristics can be observed?

<p>prices and wages are completely flexible</p> Signup and view all the answers

What is the reason inflation is not a concern in the Keynesian zone of the aggregate supply curve?

<p>due to excess capacity in the labor market, intermediate goods markets, and raw materials markets</p> Signup and view all the answers

What is the main focus of the debate between Keynesian and Neoclassical economists?

<p>timing</p> Signup and view all the answers

What is the period of time for real GDP when wages are sticky in response to a change in demand?

<p>This is a period of time for real GDP when wages are sticky</p> Signup and view all the answers

In the equation for Aggregate Demand (AD), what does I refer to?

<p>investment spending</p> Signup and view all the answers

What does it mean if the AS-AD curves are in equilibrium in the vertical range of the AS curve?

<p>the economy is producing at or near its potential GDP</p> Signup and view all the answers

What does the economic model of aggregate demand and aggregate supply help explain?

<p>shifts in the real GDP and the price level</p> Signup and view all the answers

A ________ is a graph of an upward-sloping curve representing the relationship between the aggregate price level and the quantity of output produced by businesses.

<p>aggregate supply curve graph</p> Signup and view all the answers

Using the context of an economy's existing resources, market and legal institutions, what term is used to describe the maximum quantity that an economy can produce?

<p>potential GDP</p> Signup and view all the answers

Study Notes

Keynesian Economics

  • Recessions are primarily caused by insufficient aggregate demand.
  • Factors influencing consumption expenditure include disposable income and consumer confidence.
  • Business investment is highly volatile due to its dependence on confidence and expectations.
  • Government actions like tax cuts or increased spending are aimed at boosting aggregate demand in recessions.
  • An increase in U.S. imports subtracts from aggregate demand, as it represents spending not on domestic goods.
  • An effective stimulant for a recessionary economy aligns with Say's Law by providing subsidies for investors.
  • Aggregate demand's increase in the Keynesian model can lead to a rise in the aggregate price level when aggregate supply reaches potential output.

Neoclassical Economics

  • Say's Law posits that supply creates its own demand, indicating a self-correcting economy that functions at potential GDP.
  • In the neoclassical view, shifts of the aggregate demand curve have minimal impact on GDP due to the long-run aggregate supply being at potential.
  • If the aggregate supply is vertical, it reveals that output quantity remains unaffected by changes in aggregate demand.
  • Neoclassical economists emphasize long-term growth over short-term recession management, believing the economy self-adjusts.
  • Expansionary fiscal policy is viewed as ineffective in the long run due to flexible prices negating any demand increase.

Aggregate Demand and Supply Dynamics

  • The aggregate demand (AD) formula is composed of consumption, investment, government spending, and net exports.
  • In equilibrium, the economy operates at or near potential GDP, with real GDP being responsive to price changes across various ranges of the aggregate supply curve.
  • The spending (or expenditure) multiplier demonstrates that changes in autonomous spending lead to proportionally larger shifts in real GDP.
  • Price and wage stickiness during short-run adjustments can lead to inefficiencies and prolonged economic malaise.

Miscellaneous Economic Concepts

  • An inflationary gap occurs when output surpasses potential GDP, while a recessionary gap indicates output below potential GDP.
  • Menu costs refer to expenses incurred by firms in adjusting prices; these costs contribute to price stickiness.
  • Human capital signifies the skills and education of the workforce, enhancing productivity.

Expectations in Economics

  • Adaptive expectations signify adjustments based on historical data, whereas rational expectations rely on current information to forecast future economic conditions.
  • Keynes' Law focuses on the premise that demand generates supply, oppositely framed by Say's Law which suggests supply creates demand.

Policy Responses to Economic Conditions

  • Keynesian responses to recession scenarios include stimulus measures through increased government spending, while neoclassical perspectives advocate reducing labor union influence.
  • The vertical long-run aggregate supply curve implies minimal dependence on aggregate demand for determining long-term output.
  • Technological advancements can shift potential GDP to the right, promoting economic growth.

Economic Indicators and Models

  • Potential GDP reflects the maximum output achievable when resources are fully utilized and is critical for assessing economic health.
  • The AS-AD model is fundamental in analyzing macroeconomic equilibrium and understanding the impacts of shifts in supply and demand on price levels.

Overall Economic Framework

  • The debate between Keynesian and neoclassical economists primarily centers on timing and the effectiveness of government intervention in managing the economy.
  • Short-term fluctuations may result from sticky wages and prices, while long-run adjustments tend to stabilize around potential GDP, showcasing the flexibility of wages and prices in the neoclassical model.

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Test your understanding of key concepts in Keynesian and Neoclassical economics with these flashcards. Each card presents important definitions and principles that highlight the differences and similarities between the two schools of thought.

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