Macro eco


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Macro eco

  1. 1. Presented by : Ajinkya Badwe PH 0901 Alok Kalgi PH 0902 Amit Palande PH 0903 Aniket Kulkarni PH 0904 Anoop Kr. Singh PH 0905 Tushar Paul PH 0949
  2. 2. Introduction Keynesian Economics is a macroeconomic theory based on the ideas of the 20th century economist John Maynard Keynes He provided the framework for synthesizing a host of economic ideas present between 1900 and 1940 The theories forming the basis of Keynesian Economics were first presented in “The General Theory of Employment, Interest and Money”, in 1936
  3. 3. Advocacies Keynesian Economics advocates a mixed economy – predominantly private sector, but with a large role of the government and the public sector It argues that private sector decisions, sometimes, lead to inefficient macroeconomic outcomes Therefore, the Government and the Central Bank must exercise control with effective monetary and fiscal policies
  4. 4. Milestones Keynesian Economics served as the economic model during the latter part of the Great Depression, at the end of World War II, and during Capitalism (1945 – 1973) This theory is somewhat of a middle way between laissez- faire, capitalism and socialism During the recent economic crisis, this theory provided the underpinnings for the plans to rescue the world economy
  5. 5. Overview In Keynes’ theory, some micro-level actions of individuals and firms can lead to aggregate macroeconomic outcomes, where the economy operates below its potential output and growth Keynes contented that the aggregate demand for goods might be insufficient during economic downturns This may lead to unnecessarily high unemployment and loss of potential output
  6. 6. Solution According to Keynes, the solution to depression is to stimulate the economy Induce investments through a reduction in interest rates and government investment in infrastructure These steps would, in general, result in more liquidity in the system, leading to increased demand and production ( the initial investment leads to a cascade effect )
  7. 7. Neo-Keynesian Economics Neo-classical theory supports that the two main costs that determine the demand and supply are – labour and money Through the distribution of monetary policy, demand and supply can be adjusted If labour is more than the demand, then wages would fall until hiring began again If there is too much saving, then the interest rates would fall until people cut their savings rate or started borrowing
  8. 8. Wages and Spending The high unemployment during the Great Depression was due to high and rigid real wages Keynes argued that – it is the nominal wages that are negotiated between the employers and employees People will resist any nominal wage reductions, until they see other wages falling and a general reduction in prices
  9. 9. Wages and Spending Real wages can be reduced in two ways : - Nominal wages can be reduced - Price level can rise However, reduced wages can lead to reduced aggregate demand, making the situation worse Similarly, when prices are falling, people would expect them to fall further
  10. 10. Say’s Law If the expansion of aggregate demand leads to P AD AS higher employment, then prior to the expansion involuntary unemployment must have prevailed. yf y This amounts to a refutation of Say’s Law based on asymmetry of wage and price responses.
  11. 11. Some AccountingAssume a closed economy:• Output = Aggregate Expenditure = National Product Y = E = C + I + G = C + Ir + G• But Y is also income, and from income we purchaseconsumer goods (C), save (S), or pay taxes (T), so Y=C+S+T• So that C+S+T=C+I+G Or S+T=I+G• Which means that saving and taxes paid by the publicmust finance investment and government spending.
  12. 12. Is Consumption related to Income? 7000 6000 Consumption 5000 4000 3000 2000 1000 0 0 2000 4000 6000 8000 10000 Real GDPU.S. Annual Data, 1929 - 2001
  13. 13. Excessive Saving Excessive savings (i.e.. savings beyond planned investments), could encourage recession Excessive savings are the result of falling investments, over investments in earlier years, or pessimistic business expectations If savings did not fall immediately in step, then the economy would decline
  14. 14. ExplanationAssume that fixed investment falls :i. Saving does not fall as much as the interest rates fallii. Planned fixed investments are made on long-term expectations, spending does not rise as much as the interest rates falliii. The supply of and demand for the money determines the interest rates, in the short runiv. Excessive saving corresponds to unwanted accumulation of inventories, called “ general glut “
  15. 15. Fiscal Policy Keynes’ theory suggested that active government policy could be effective in managing the economy He advocated countercyclical fiscal policy – deficit spending (fiscal stimulus) when the nation’s economy is in recession The argument is that the government should solve problems in the short run
  16. 16. Plus Points This response should be adopted only when the unemployment rate is persistently high Here, “crowding out” is minimal, raising the business output, cash flow, profitability and business optimism Government spending on infrastructure would be beneficial in the long term
  17. 17. Multiplier effect Exogenous increase in spending, such as an increase in government outlays, increases total spending by a multiple of that increase Government could stimulate a great deal of new production if-i. The people who receive this money spend most on consumption, and save the restii. This extra spending allows businesses to hire more people, in turn increase consumer spending
  18. 18. Result This process is continuous At each step the increase in spending is smaller than in the previous step, thus reaching equilibrium The rise in imports and tax payments at each step reduces the amount of induced consumer spending and the size of the multiplier effect
  19. 19. Interest rates By this theory, the amount of investments was determined by long-term profit expectations, and less by the interest rates This facilitates the regulation of the economy through the monetary policy This approach would be effective during normal times to stimulate the economy
  20. 20. Main TheoriesThe two key theories of mainstream Keynesian economics are :I. The “ IS – LM Model “ of John HicksII. The “ Phillips Curve “
  21. 21. IS – LM Model It was with John Hicks, that Keynesian Economics produced a clear model to determine policy and economic education Aggregate demand and employment are related to three exogenous quantities :i. The amount of money in circulationii. The government budgetiii. The state of business expectations
  22. 22. Phillips Curve Phillips curve indicated that decreased unemployment implied increased inflation Keynes had predicted that falling unemployment would cause a higher price, not a higher inflation rate The economist could use the IS-LM model to predict that an increase in money supply would raise output and employment Then use the Phillips curve to predict an increase in inflation
  23. 23. - John Maynard Keynes
  24. 24. Thank You