Neoclassical Macroeconomics Overview

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.

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.