The (neo) Classical Model

The Classical Model

Today we build up our first macro model – the classical model. Prior to Keynes’ publication of the General Theory of Employment, Interest, and Money (1936), there was not a conception of “macroeconomics.” There was just this idea of economics.

Why the difference? 

Well, when we develop the Keynesian model, we’ll see that we need a theory of output and employment determination that is distinct from the theories that describe individual and firm level decisions. This is because as I suggested earlier in the course, there is this phenomena in economics we call the “paradox of thrift,”  which shows how seemingly rational decisions to save for the future can lead to the inability of society as a whole to do so. This is closely related to Say’s Law and its failure, which leads to unemployment, declining incomes, and ultimately diminishes our ability to save.

In order to understand Keynes’ critique of Say’s Law we need to first lay out the classical model which relies upon Say’s Law.

Investment and Consumption

Components of GDP

Some basic, but important, insights into economics

This intended to introduce students to economics for the first time, but I think it fits well with where we're at in the course. I think he does a pretty fair treatment of the strengths and weaknesses inherent in economics, whether we are talking micro or macro. This would useful to you as you review for the quiz.

GDP: What to count?

Here's a video that elaborates a little on what is and is not counted in GDP.

 

Circular Flow of Income and Expenditures

If you are struggling with the circular flow diagram, take a look at this video. It gets to the point. But, be careful - it's a little too simple. Clearly, the economy has more than one person. Also, this model does not allow for leakages and injections, which are crucial for understanding things like growth and determination of the level of employment.

Basics of Macro

Macro: The Basics

In economics, there are several ways to look at the economy. The approaches we begin with in principles courses are microeconomics and macroeconomics. As we have done over the last few weeks, we have looked at the micro questions. How might choices be made given a limited budget, or how might a firm respond to a price change. We looked at how the forces of supply and demand work to bring about an equilibrium price in a single market. This takes a worm’s eye view of the economy. We are looking at very detailed, specific parts of the economy. The individual consumer or the individual firm are the objects of analysis in microeconomics.

In macroeconomics we take a bird’s eye view. In a way, we are looking down on the economy from space and trying to examine how the interactions of all those individuals living and working together, result in measurable economic phenomena as a whole.

So what phenomena are we looking for here?