Questions and Answers
What does the neoclassical perspective on macroeconomics emphasize?
The neoclassical perspective emphasizes that in the long run, the economy rebounds back to its potential GDP and natural rate of unemployment.
What are the key building blocks of the neoclassical approach?
The neoclassical approach is based on the expansion of potential GDP over time and the flexible adjustment of prices and wages in the long run.
How is potential GDP shown in the neoclassical model?
Potential GDP is shown as a vertical line in the neoclassical model.
How is the aggregate supply curve drawn in the neoclassical model?
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What does the neoclassical supply and demand model state about production levels?
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What happens when there is a decrease in aggregate demand due to a decline in consumer confidence?
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What is the neoclassical view on the impact of changes in aggregate demand?
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What is the Keynesian economists' criticism of neoclassical theory regarding recession adjustments?
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What does the theory of rational expectations hold?
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How does a neoclassical long-run aggregate supply curve affect the Phillips curve?
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Study Notes
Neoclassical Perspective on Macroeconomics
- Emphasizes long-run return of the economy to potential GDP and natural rate of unemployment.
- Suggests Keynesian and neoclassical economics complement each other; Keynesian for short-run, neoclassical for long-run analysis.
Neoclassical Argument and Building Blocks
- Argues the economy adjusts back to potential GDP over time.
- Two key building blocks:
- Expansion of potential GDP drives long-term economic size.
- Prices and wages, though sticky in the short run, adjust flexibly over the long run.
Potential GDP in the Neoclassical Model
- Represented as a vertical line in the aggregate supply and demand model.
- Indicates that aggregate supply determines real GDP, independent of aggregate demand levels.
- Economic growth shifts potential GDP and the AS curve rightward over time.
Aggregate Supply Curve
- Drawn as a vertical line at potential GDP level in the neoclassical model.
- Determines real output level regardless of aggregate demand positioning.
- As productivity increases and potential GDP expands, the AS curve shifts right.
Short-run and Long-run Shifts
- Short-run production above potential GDP can't be sustained long-term.
- Initial aggregate demand surge results in higher price levels, not increased output over time.
Decline in Aggregate Demand Effects
- A fall in consumer confidence leading to less consumption shifts AD from AD0 to AD1.
- This shift moves equilibrium from E0 to E1, causing output decline and rising unemployment as it falls below potential GDP.
Impact of Changes in Aggregate Demand
- In the neoclassical view, changes in aggregate demand impact output and unemployment only in the short run.
- Long-run real GDP size dictated by potential GDP and aggregate supply, with price flexibility.
Keynesian Criticism of Neoclassical Theory
- Critiques the neoclassical assumption that adjustments from recession to potential GDP occur quickly, suggesting it may be more theoretical than viable.
Theory of Rational Expectations
- Suggests people form accurate future expectations using all available information.
- In economies with rational expectations, economic adjustments can occur rapidly.
Phillips Curve and Neoclassical Long-run Aggregate Supply
- A vertical long-run aggregate supply curve suggests there is no trade-off between inflation and unemployment in the Phillips curve.
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Description
This quiz explores the neoclassical perspective on macroeconomics, focusing on its emphasis on long-term economic stability and potential GDP. It discusses how this perspective complements Keynesian economics rather than opposing it. Test your understanding of these fundamental concepts in macroeconomic theory.