key Points Chapter 11 · The English economist John Maynard Keynes developed a model that provided an explanation for the high and prolonged rate of unemployment of the Great Depression. · In the Keynesian model, equilibrium occurs when the spending on consumption, investment, government purchases, and net exports is equal to total output. Firms will produce only the quantity of goods and services they believe consumers, investors, governments, and foreigners plan to buy. If this spending level is less than full-employment output, firms will not alter their production levels and the less than full-employment rate of output will persist. Keynes believed this was the situation during the Great Depression. · According to the Keynesian view, fluctuations in total spending (aggregate demand) are the major source of economic instability. Keynesians believe that market economies have a tendency to fluctuate between economic booms driven by excessive demand and recessions resulting from insufficient demand. The multiplier concept magnifies these fluctuations. · When an economy is in a recession, Keynesians do not believe that reductions in either resource prices or interest rates will promote recovery. As a result, market economies are likely to experience recessions that are both severe and lengthy. · The federal budget is the primary tool of fiscal policy. The Keynesian model highlights the use of fiscal policy as a tool with which to maintain demand at a level consistent with full employment and price stability. · Rather than balancing the budget annually, Keynesians believe that fiscal policy should reflect business cycle conditions. During a recession, fiscal policy should become more expansionary (a larger deficit should be run). During an inflationary boom, fiscal policy should become more restrictive (shift toward a budget surplus). · Changes in fiscal policy must be timed properly if they are going to exert a stabilizing influence on an economy. The ability of policy-makers to time fiscal policy changes in a countercyclical manner is reduced by · (1) the inability of the political process to act rapidly, · (2) the time lag between when a policy change is instituted and when it affects the economy, and · (3) the inability to forecast accurately the future direction of the economy. · Automatic stabilizers help promote stability because they are able to add demand stimulus during a recession and restraint during an economic boom without legislative action. · Although an abrupt increase in saving may exert an adverse impact on the economy in the short run, saving provides the financing for investment that powers long-term growth. Moreover, a healthy economy is dependent on households saving regularly and avoiding excessive debt. Key Points chapter 12 · The crowding-out model indicates that expansionary fiscal policy will lead to higher real interest rates and less private spending, particularly for investment. In an open economy, the higher in ...

1. key Points Chapter 11
· The English economist John Maynard Keynes developed a
model that provided an explanation for the high and prolonged
rate of unemployment of the Great Depression.
· In the Keynesian model, equilibrium occurs when the spending
on consumption, investment, government purchases, and net
exports is equal to total output. Firms will produce only the
quantity of goods and services they believe consumers,
investors, governments, and foreigners plan to buy. If this
spending level is less than full-employment output, firms will
not alter their production levels and the less than full-
employment rate of output will persist. Keynes believed this
was the situation during the Great Depression.
· According to the Keynesian view, fluctuations in total
spending (aggregate demand) are the major source of economic
instability. Keynesians believe that market economies have a
tendency to fluctuate between economic booms driven by
excessive demand and recessions resulting from insufficient
demand. The multiplier concept magnifies these fluctuations.
· When an economy is in a recession, Keynesians do not believe
that reductions in either resource prices or interest rates will
promote recovery. As a result, market economies are likely to
experience recessions that are both severe and lengthy.
· The federal budget is the primary tool of fiscal policy. The
Keynesian model highlights the use of fiscal policy as a tool
with which to maintain demand at a level consistent with full
employment and price stability.
· Rather than balancing the budget annually, Keynesians believe
that fiscal policy should reflect business cycle conditions.
During a recession, fiscal policy should become more
expansionary (a larger deficit should be run). During an
inflationary boom, fiscal policy should become more restrictive
(shift toward a budget surplus).
· Changes in fiscal policy must be timed properly if they are

2. going to exert a stabilizing influence on an economy. The
ability of policy-makers to time fiscal policy changes in a
countercyclical manner is reduced by
· (1)
the inability of the political process to act rapidly,
· (2)
the time lag between when a policy change is instituted and
when it affects the economy, and
· (3)
the inability to forecast accurately the future direction of the
economy.
· Automatic stabilizers help promote stability because they are
able to add demand stimulus during a recession and restraint
during an economic boom without legislative action.
· Although an abrupt increase in saving may exert an adverse
impact on the economy in the short run, saving provides the
financing for investment that powers long-term growth.
Moreover, a healthy economy is dependent on households
saving regularly and avoiding excessive debt.
Key Points chapter 12
· The crowding-out model indicates that expansionary fiscal
policy will lead to higher real interest rates and less private
spending, particularly for investment. In an open economy, the
higher interest rates will also lead to the following secondary
effects: an inflow of capital, an appreciation of the dollar, and a
reduction in net exports. The crowding-out theory implies that
these secondary effects will largely offset the demand stimulus
of expansionary fiscal policy.
· The new classical model stresses that financing government
spending with debt rather than taxes changes the timing, but not
the level, of taxes. According to this view, people will expect
higher future taxes, which will lead to more saving and less
private spending. This will tend to offset the expansionary

3. effects of a deficit.
· Keynesian and non-Keynesian economists are now largely in
agreement on the following three issues:
· (1)
Proper timing of discretionary fiscal policy is both difficult to
achieve and crucially important,
· (2)
automatic stabilizers reduce the fluctuation of aggregate
demand and help promote economic stability, and
· (3)
fiscal policy is much less potent than early Keynesians thought.
· When fiscal policy changes marginal tax rates, it influences
aggregate supply by altering the attractiveness of productive
activity relative to leisure and tax avoidance. Other things
constant, lower marginal tax rates will increase aggregate
supply. Supply-side economics should be viewed as a long-run
strategy, not a countercyclical tool.
· Keynesian economists believe that increases in government
spending financed by borrowing will increase aggregate demand
and help promote recovery from a serious recession like that of
2008–2009. Non-Keynesian economists argue that Keynesian
policies will lead to higher future interest rates and taxes,
inefficient use of resources, and wasteful rent-seeking that will
both hinder recovery and slow future economic growth.
· Tax cuts can generally begin to exert an impact on the
economy more rapidly than spending increases. Further, rate
reductions and permanent rate changes will exert a larger
impact than tax rebates and temporary tax cuts.
· Political decision-makers responded to the 2008–2009
recession with large increases in both government spending and
budget deficits. The large deficits pushed the federal debt to
levels unseen since World War II.
· High levels of debt as a share of the economy pose a potential
danger in a vicious cycle of rising interest costs, higher taxes,
and slower economic growth. As long as worldwide interest
rates remain low, the current levels of debt present in the

4. United States are unlikely to result in serious problems.
However, if interest rates rise in the future, the situation could
change.
Key Points special topic 4
· John Maynard Keynes and Friedrich Hayek are giants in the
economics profession. Their theories and ideas represent
contrasting views on several of the central issues of economics.
· Although there are many different schools of thought in
economics, they can be grouped roughly into (1) those that view
market outcomes as often problematic and government
interventions as effective and (2) those that alternatively view
market outcomes as generally efficient and government
interventions as suffering from various shortcomings.
· Keynes believed that market economies were inherently
unstable and government intervention in the form of fiscal and
monetary stimulus could be used effectively to promote
economic stability. Hayek believed that economic instability
was primarily the result of malinvestment generated by
monetary and credit expansion and that government stimulus
would slow market adjustments and the recovery process.
· Keynesians stress the role of aggregate demand and spending
in the macroeconomy and view savings as a leakage detrimental
to the economy. In contrast, Hayekians have a more favorable
view of the role of savings in providing the funds necessary for
investment and growth in productivity and output.
· Keynesians believe that government intervention can generally
improve market outcomes. Hayekians believe that policy-makers
simply do not have the information or incentives to plan the
economy effectively and that their efforts to do so would be far
less efficient than allocation through markets.
· Keynesians believe that the job of the economist is to develop
policies that will reduce economic instability and correct market
failures. Keynesian analysis largely ignores how economic
incentives influence the operation of the political process.

5. Hayekians recognize that the political incentive structure often
caters to well-organized interest groups and results in the
adoption of shortsighted policies. Thus, they stress the
importance of legal and political institutions that will provide
both market participants and political decision-makers with
incentives to engage in productive rather than counterproductive
actions.