Theories of Economics, US Economic Policy, Economic Indicators, and the
Global Economy
The major theorists in each area are:
1) Classical
2)Keynesian
3) Monetarist
Adam SMITH
John Maynard KEYNES
Milton FRIEDMAN
Friedrich August Von HAYEK
The term ‘classical’ refers to work done by a group of economists in the 18th and
19th centuries. Much of this work was developing theories about the way
markets and market economies work. Much of this work has subsequently
been updated by modern economists.
CLASSICAL THEORY
Adam SMITH (1723-1790)
*Father of Economics
*Developed much of the theory about markets that we
regard as standard theory now.
• Scottish
•Graduated from Glasgow at the age of 17
• fellow at Oxford
• lecturer in Scotland.
Adam Smith argues that it was market forces that ensured the
production of goods and services,
ensuring profit. A laissez-faire environment would
increase competition and keep costs down. All this can be
done without GOVERNMENT INTERVENTION.
This was the basis of the free market economy.
KEYNESIAN THEORY
Keynesian economics is a theory suggested by John Maynard Keynes in which government
spending and taxation is used to stimulate the economy. This
theory is also called fiscal policies or DEMAND-SIDE ECONOMICS.
John Maynard KEYNES (1883-1946) is perhaps one of the best known economists. His work changed the whole
face of post-World War II economic policy.
*graduate of Cambridge --studied Classics and Math.
Keynes felt that a recession (or slump or trough) was a short-run problem
stemming from a lack of demand. His theory was that the government should
actively intervene in the economy to manage the level of demand.
The government could stimulate the economy by running a budget deficit. It
could create jobs, decrease interest rates, and encourage spending. When the private sector was spending again, the government could trim its spending
and pay off the debts they had accumulated during the slump.
The idea, according to Keynes, was to balance
your budget in the medium term, not in
the short-run.
One of his best known quotes summarizes this focus on the short-run
policies:
“In the long-run we are all dead.”
Friedrich August von HAYEK (1899-
1992)
*born in Vienna, was a great believer in free
markets
*Nobel Prize in Economics.
*passionate opponent to Socialism and campaigned to make people aware of the dangers of Socialism.
Hayek argued that the growth of the money supply should
be restricted, even if that led to high unemployment, as it was
the only way to control inflation.
MONETARIST THEORY
Monetarists are a group of economists so named because of their preoccupation with money and its
effects.
Their view that the main cause of changes in aggregate output and the price level are fluctuations in the money supply. The FEDERAL
RESERVE is responsible for monetary policy in the United States. In his view, any attempt to manage the level of demand (as in Keynesian
economics) would simply be de-stabilizing and make things worse. The
role of government is simply to use its monetary policy to control
inflation and supply-side policies to make markets work better and reduce unemployment.
Federal Reserve: Minneapolis
Milton FRIEDMAN (1912- ) is the
best known monetarist. He
followed the ideas of Hayek. He is one of the
select elite in our Virtual economy who has won a Nobel Prize in
economics (1976).
Friedman is a great believer in the power of the free market and
much of his work has been based on this.
MONETARIST THEORY
This school of thought, suggested by Milton Friedman,
stressing the importance of stable monetary growth to control inflation and stimulate long-term growth is popular
among conservatives. The FEDERAL
RESERVE SYSTEM conducts monetary policy in the United
States.
Federal Reserve: Dallas
Timeline of Famous
Economists
U.S. Economic PolicyMaintaining freedom of choice in the
marketplace is the basis of the free-enterprise system. Government plays a limited but important role in the protection of individual economic freedoms.
Individuals have the right to the basic economic freedoms enjoyed in a free market society. The government is responsible for protecting these freedoms
U.S. Economic PolicyEconomic freedoms of individualsAbility to earn moneyRight to purchase propertyRight to spend incomes on goods and servicesRight to choose occupations or change jobsRight to make choices about where and how
much to saveRight to start new businessesThe government has created certain
consumer-protection laws and agencies.
U.S. Economic PolicyA strong relationship exists between the
economic and political freedoms enjoyed by citizens of free and democratic nations.
U.S. Economic PolicyThe degree of economic freedom in a
nation tends to be directly related to the degree of political freedom its citizens enjoy.
Democratic nationsHigh degree of economic freedomHigh degree of political freedom
Authoritarian nations (Autocracies)Limited economic freedomLimited political freedom
U.S. Economic PolicyFormulation of economic policies requires
an understanding of accurate measures of the economy’s performance.
Economic IndicatorsAdvance Monthly Retail SalesAdvance Report on Durable GoodsConstruction SpendingCurrent Account BalanceManufacturers’ Shipments, Inventories, and
Orders
Economic IndicatorsManufacturing and Trade Inventories and
SalesNew Home SalesNew Residential ConstructionPersonal Income and SpendingWholesale Trade
Economic IndicatorsLet’s look at a few closer up:Gross Domestic Product (GDP) is the total dollar value of
all final goods and services produced in a year.Consumer price index measures the monthly price
changes of sample consumer goods and services.Unemployment rate is the percentage of the labor force
without jobs.Balance of trade is the difference in dollar value between
imports and exports.Stock market averages are select groups of stocks whose
performance is averaged, and over time, the averages serve as an indicator for the market.
Productivity is the amount of output per unit of input over a period of time.
U.S. Economic PolicyProductivity and the standard of living are
generally higher in economies that have limited government planning and limited control of the economy.
Monetary and Fiscal PoliciesTwo major instruments for influencing
economic activity are monetary and fiscal policies.
U.S. Economic PolicyChanges in fiscal and monetary policies can
stimulate or slow the economy.
The Federal Reserve System serves as the United States central bank.
The Federal Reserve Board controls monetary policy by changing the availability of loanable funds and/or adjusting interest rates.
U.S. Economic PolicyThree instruments of monetary policy are
reserve requirements, discount rates, and open-market operations.
The government can use fiscal policies such as changes in taxing, changes in spending, and the issue of government bonds to influence economic activity.
U.S. Economic PolicyMany public goods and services would not
be available if they were not provided by the government.
U.S. Economic PolicyGovernment-provided public goods and
services, sometimes called “collective” goods and services, benefit many but would not be available to everyone if individuals had to provide them.
Taxes and/or fees pay for the production of government-provided goods and services.
U.S. Economic PolicyExamples of goods and services provided by the
government InfrastructurePublic health and safetyPublic schools
Reasons why government provides public goods and services
It is more efficient.The goods or services may benefit everyone, not only a
purchaser.The value of the goods or services is greater than
individual consumers could afford. It promotes economic equity.
Government RegulationThe United States government creates laws
and agencies to regulate production and exchange activities, conduct research, and establish guidelines for consumer rights and safety. The government can also intervene in labor-management relations and can regulate competition in the marketplace.
Government RegulationGovernment agencies created to protect
consumer safety and against fraud and deception
The Consumer Product Safety Commission ensures safety of products other than food, drugs, and cosmetics
The Food and Drug Administration ensures the safety of food, drugs, and cosmetics
The government can intervene in labor-management relations and can regulate competition in the marketplace.
Government RegulationProtecting the environment is a public
service.The government sets regulations and levies
fees to ensure that the producer pays all costs resulting from polluting. The government also subsidizes pollution reduction efforts.
Government RegulationProperty rights of an individual are relative
and limited.Individuals have the right of private
ownership, which is protected by negotiated contracts that are enforceable by law. However, the rights of a society as a whole rank above those of the individual.
Government RegulationContracts are legally binding.Individuals enter into agreements
(contracts) with one another to buy and sell goods and services. Whether written or oral, these agreements are legally binding.
The Global EconomyDemocracy and capitalism go hand in
hand as they both promote freedom.With technology, trade extends
beyond our borders most of the time.International trade affects everyone
everywhere.The global economy deeply affects
national security and foreign policy.Recently, industrial espionage is the
most powerful form of spying.
The Global EconomyThe economies of individual nations are
interdependent.
The economy of the United States depends on resources and markets around the world for the production and sale of resources, goods and services.
Total world production is greater when nations specialize in the production of those products that they can produce most efficiently.
The Global EconomyUnited States businesses have become
multinational in their quest for productive resources, markets, and profits. United States firms may move factories to other countries to reduce costs (off-shoring).
International trade provides Virginia and the United States with goods and services for which they do not possess absolute or comparative advantage.
The Global EconomyVirginia and United States businesses have
become multinational in their quest for resources, markets, and profits.
Virginia and the United States benefit when they produce goods and services for which they have a comparative advantage, and trade for other items.
The Global EconomyAdvances in technology allow businesses to
get skilled work, such as engineering and accounting, done by people who remain in their home countries (i.e., to outsource this work). This increases the supply of workers and holds wages and costs of production down. Immigration brings workers into the country and increases the supply of labor.
Global EconThe Global Economymy
Making foreign policy decisions requires balancing competing or contradictory foreign policy goals.
The Global EconomyAs foreign countries develop and grow,
they demand more products and natural resources, such as oil, pushing up prices.
The Global EconomyWhen the United States imports more
goods and services than it exports, the difference is the trade deficit.
Canada, Mexico, the European Union, China, and Japan are the major trading partners of the United States.
The Global EconomyGlobal Partnerships
European UnionNorth American Free Trade AgreementObama’s Initiative in the Far East