Feb. 3 (Bloomberg) -- Mohamed El-Erian, chief executive officer of Pacific Investment Management Co., talks with Bloomberg's Tom Keene and Ken Prewitt about the outlook for the U.S. economy. El-Erian also discusses President Barack Obama's budget and the bond market. (Source: Bloomberg)
After discussing the classical model, the chapter presents material on the sources
of long-run economic growth (with particular emphasis on productivity growth)
and the importance of infrastructure. The chapter concludes with a section on innovation waves.
Extended Examples in the Chapter
The Changing Face of Innovation Waves
Looking back to Schumpeter’s creative destruction, this section argues that the time between waves of innovation is becoming shorter. It cites the work of William
Baumol, who contends that capitalism’s ability to produce a steady stream of new
ideas and processes has made capitalism the most efficient growth machine and the
best economic system for generating growth.
The sources cited for this section are “Catch the Wave: The Long Cycles of
Industrial Innovation are Becoming Shorter,” from The Economist, February 19,
1999, and The Free-Market Innovation Machine: Analyzing the Growth Miracle of
Capitalism, by William J. Baumol (Princeton: Princeton University Press, 2002).
The Ch. 17 material (below) we will return to as pre-Test material but I will introduce the new material after this brief interlude.
Ch. 18 Keynesian Macroeconomics
Keynesian Macroeconomics, 8:22
http://www.pyrolitical.com discusses how Keynesian economic theories are used by the U.S. government to determine when and where to spend money, or stimulate the economy. In this video there is a brief overview of these theories and their effects on the market. Contrasted with the Austrian view of economics.
Chapter Outline 18 Keynesian Macroeconomics
The construction of this chapter takes students from aggregate expenditures and its components (and the determinants for each), through a simple Keynesian model
and the multiplier, and then completes the model adding government and the foreign sector. At this point recessionary and inflationary gaps are examined. It is worth noting that the extension of the simple Keynesian model to the complete
model (i.e., the addition of government and net exports) is illustrated using the
Savings and Investment graph, while the illustration of the recessionary and inflationary gaps employ the complete aggregate expenditure figures (similar to those used earlier in the chapter). The chapter concludes with a section on the Great Depression and Keynesian analysis.
Aggregate Expenditures, p. 474, :20
Samuelson's Keynesian cross diagram is an attempt to capture the essence of Keynes' theory of effective demand. The blue line represents aggregate expenditure on domestically produced goods and services. Of all the components of aggregate expenditure, only the level of consumption is assumed to be a function of income; the other components are assumed to be autonomous. The red line expresses the accounting identity that aggregate expenditure is equal to national income. The model shows that a change in autonomous expenditure leads to a larger-sized change in national income, a relationship known as the multiplier effect.
Some Simplifying Assumptions, p. 474
Consumption and Saving, p. 475
Average Propensities to Consume and Save, p. 477, 11:37
An interview with John Quelch, Professor, Harvard Business School. In a tough economy, companies can succeed if they understand their customers' evolving consumption patterns and fine-tune their marketing strategies accordingly.
Marginal Propensities to Consume and Save, p. 478, 3:25
Senior Lecturer in Politics, Economics, and Statistics Dr. John "Jack" Emens talks about about what the marginal propensity to Consume (MPC) is and how it effects the flow of currency through the economy.
Other Determinants of Consumption and Saving, p. 479
Investment, p. 480, 9:51
The difference between investment and consumption.
Investment Demand, p. 481
Other Determinants of Investment Demand, p. 481
Aggregate Investment Schedule, p. 482
Checkpoint: Aggregate Expenditures, p. 483
The Simple Keynesian Model, p. 483
Macroeconomic Equilibrium in the Simple Model, p. 484, 5:33
Just as demand & supply yield the price and quantity of a particular product, Aggregate Demand (AD) & Aggregate Supply (AS) determine the macroeconomic equilibrium - price level (telling whether we have inflation), quantity of goods and services (real GDP), and, indirectly, unemployment.
The Fiscal policy and the multiplier effect Multiplier Effect, p. 485, 9:11
The Multiplier, p. 486, 3:48
Australia leading global National Broadband Network developments
The decision from the Australian government to launch a $43 billion national FttH broadband network is a clear indication that they believe broadband is essential infrastructure. It fulfils a national purpose as its trans-sector multiplier effect delivers massive social and economic benefits in healthcare, education, energy and the environment. A digital economy requires an open broadband infrastructure, and for that to work it can only be built by a utility (NBN Co). While there certainly are questions regarding the business model and the investment plan, there is widespread support for the visionary plan. During 2010 the business model needs to be developed, which will take into account the socio-economic benefits the infrastructure can deliver to the country.
The Multiplier Works in Both Directions, p. 487
Checkpoint: The Simple Keynesian Model, p. 488
The Full Keynesian Model, p. 488
Adding Government Spending and Taxes, p. 488
Tax Changes and Equilibrium, p. 489
The Balanced Budget Multiplier, p. 490, 10:39
Balance budget multiplier in Germany discussing Keynes.
This film examines the multiplier effects of balanced budget expenditure in Germany, where the government has increased taxes in the West to fund development of the East.
Adding Net Exports, p. 490
Recessionary and Inflationary Gaps, p. 491
Recessionary Gap, p. 491
Inflationary Gap, p. 492
Checkpoint: The Full Keynesian Model, p. 493
The Great Depression and Keynesian Analysis, p. 493
If we consider numerous sites that exist with photos of bread lines and other scenes typical of the time we will understand better the economic devastation.
Oral history may be helpful in this regard as well. Some students may have grandparents who remember the Great Depression.
Macro in microcosm. Students may share information about where they
work. Ask students employed in service locations like restaurants if they’ve ever
been told not to come in because the “place is not busy.” We can relate the impact on your earnings and spending, and in turn the effects on others, to show in a simple way the roots of the multiplier process.
Aggregate Expenditures, p. 494
Question: Figure 3 earlier illustrated that investment spending is much more
volatile than consumption spending. Why is this?
The point is to check that students can: apply their knowledge of the determinants of consumption spending and investment to help evaluate the relative volatility of each component of aggregate expenditures.
The Simple Keynesian Model, p. 495
Question: Business journalists, pundits, economists, and policymakers all pay
attention to the results of the Conference Board’s monthly survey of 5,000 households called the Consumer Confidence Index.
When the index is rising, this is good news for the economy and when it is falling concerns are often heard that it portends a recession. Why is this survey important as a tool in forecasting where the economy is headed in the near future?
The point is to check that students can: synthesize their knowledge of the multiplier effect of a decrease in consumer spending with the importance of consumer spending as the major portion of aggregate expenditures in order to see the potential for a decrease in consumer spending to provide impetus for a recession.
The Full Keynesian Model, p. 495
Question: If the government is considering reducing taxes to stimulate the economy
does it matter if the MPS is .25 or .33?
The point is to check that students can: understand how changes in the size of the MPS affect the value of the multiplier and so influence the impact of a policy change. By extension, students should appreciate that the government needs to estimate factors such as the multiplier in planning policy changes.
Extended Examples in the Chapter
The Great Depression and the Keynesian Analysis
This section provides data that can help capture the magnitude of the Great
Depression: the stock market lost 90% of its value compared to the beginning of the 1930s, unemployment soared from 3.2% in 1929 to nearly 25%. Moreover, the Great Depression lasted for roughly a decade. The Keynesian model can be used to illustrate the situation of the time and to explain Keynes’s reasoning that an “injection” of government spending was needed.
For more about the Great Depression, including a timeline and some photos, see the PBS Web site at http://www.pbs.org/wgbh/amex/rails/timeline/.
Important points to note: the distrust of the government and banks, the resentment of foreign workers, the persistence of the belief in the classical model (as illustrated in President Herbert Hoover’s remarks at the beginning of the period), the need to banish fear as expressed by President Franklin Roosevelt (another term for a severe lack of consumer confidence).
Examples Used in the End--of--Chapter Questions
Questions 4 and 7 reference growth rates in different countries. Question 11 references per capita income (or output). To learn more about growth rates and per capita income in different countries, visit the CIA Factbook Web site at:
For Further Analysis
Illustrating the Keynesian Model
This example can be used as an in-class small group exercise or as an individual in-class exercise. It is designed to complement the text’s material on the Keynesian model by requiring students to draw the graphs that illustrate the analysis. The student handout provides graphical illustration of the analysis behind the answers to end-of-chapter Questions and Problems 8, 12, and 14.
Keynesian Policy in Japan
This example can be used as a small group exercise or as an individual exercise.
The exercise provides an opportunity to see the Keynesian model and policies
applied to a recent example, Japan since the 1990s. This overcomes a student’s tendency to view this material as irrelevant because it is discussed in terms of the 1930s. Requiring additional research can turn this exercise into a more extensive assignment.
Read the essay “Explaining Japan’s Recession,” by Benjamin Powell (posted on
11/19/2002 on the Web site of the Ludwig von Mises Institute: http://www.mises.org) and answer the following:
1) What is the Keynesian explanation for the economic downturn in Japan?
2) What Keynesian policies have been tried? How successful have they been?
3) What does the author suggest should be done in Japan?
One challenge in this topic is to separate business investment in real plant and
equipment from people’s financial investment in stocks, bonds, etc. Students will
likely be able to grasp the importance of consumer confidence, understanding what
amounts to a “self-fulfilling prophecy;” that is, if consumers are fearful of a recession and don’t spend then that (multiplied) decrease in spending can cause a recession.
A good analogy for the Keynesian view is to liken the economy to a car with a
low battery that needs a boost to get running again.
Ch. 17 Pre-Test material:
Examples Used in the End-of-Chapter Questions
Questions 4 and 7 reference growth rates in different countries. Question 11 references per capita income (or output). To learn more about growth rates and per
capita income in different countries, visit the CIA Factbook Web site at
For Further Analysis
Immigration: Good or Bad for Productivity?
The example provided in the student handout can be used as a small group exercise
or as an individual exercise. It is also suitable to use as the basis for a classroom debate. The exercise expands on the chapter’s coverage of the sources of long-run economic growth by exploring the issue of immigration. Students are directed to read two articles about different “types” of workers and use them as a basis for analyzing the impact of immigration.
See the paper on guest-worker programs by Mark Krikorian, executive
director of the Center for Immigration Studies for a presentation of this viewpoint.
This example requires students to compare two different measures of economic
freedom and to assess what aspects of economic freedom they feel are most important.
This assignment builds on the discussion on the text and also provides an
opportunity to discuss the effects of corruption on economic growth.
The Dimensions of Economic Freedom
Visit the Web site of the Fraser Institute to read its Economic Freedom of the World report. Compare it with the Index of Economic Freedom (from the Heritage
Foundation and The Wall Street Journal) by answering the following:
1) Which are the top ten countries according to each source? (Web sites are
http://www.freetheworld.com/2006/EFWinternational-rls.pdf and http://www.
heritage.org/index/topten.cfm.) 2) What categories are included in each definition of freedom? (You may consult the list of categories in the text for the Fraser Institute; for the Heritage Foundation, see the Web site at http://www.heritage.org/research/features/index/chapters/htm/index2007_chap3.cfm).
The challenge with regard to this material is how much students may take for
granted about their freedoms and the economy in which they live. Trying to give
them another perspective will help them understand the strengths of the U.S. economy and the challenges of other countries.
Immigration: Good or Bad for Productivity?
Growth in the labor force is listed as a major source of long-run economic growth. But what causes the labor force to grow? As noted in the text, immigration is causing the U.S. population to rise faster than anyone thought. Is this good for productivity?
Read the article titled “Keeping Out the Wrong People: Tightened Visa Rules Are Slowing the Vital Flow of Professionals into the U.S.” by Spencer E. Ante in Business Week (October, 2004, pp. 90–94, available on the Web at: http://www.competeamerica.org/news/media_coverage/2004_10/20041004_bw.html.
Then read “The Worker Next Door,” by Barry R. Chiswick in The New York Times, June 3, 2006, p. A23. This article is available on the Web at: http://www.nytimes.com/2006/06/03/opinion/
Based on the two articles, assess whether immigration is good or bad for U.S. productivity.
"Mankiw's 10 principles of economics, translated for the uninitiated", by Yoram Bauman, http://www.standupeconomist.com . Presented at the AAAS humor session, February 16, 2007. For the record, the talk contains two unattributed quotes ("9 out of 5" is adapted from a line attributed to Paul Samuelson---although apparently he said it about Wall Street indices, not macroeconomists---and "wrong about things" is paraphrased from P.J. O'Rourke's Eat the Rich) and, of course, the Einstein "simple" quote is an intentional misquote. The talk is based on a published article in Annals of Improbable Research (see http://www.improb.com/airchives/paper... ), which sponsored my talk and to which you should subscribe (http://improb.com/subscribe/ ). In the paper you can see the "constructive example" of how trade can make everyone worse off (or you can just wait 50 years to see what happens with climate change). More info and other clips on my website (http://www.standupeconomist.com ), and please sign up for my email list.
William Baumol. - Air date: 06-12-99
William Jack Baumol (born February 26, 1922) is a New York University economics professor (although he is also affiliated with Princeton University) who has written extensively about labor market and other economic factors that affect the economy. He also made valuable contributions to the history of economic thought. He is among the 500 best economists in the world according to IDEAS/RePEc.
Among his better-known contributions are the theory of contestable markets, the Baumol-Tobin model of transactions demand for money, Baumol's cost disease, which discusses the rising costs associated with service industries, and Pigou taxes.
The 2006 Annual Meetings of the American Economic Association held a special session in his name, and honoring his many years of work, where 12 papers on entrepreneurship were presented. http://www.aeaweb.org/annual_mtg_pape...
The British magazine, The Economist published an article about William Baumol and his lifelong work to develop a place in economic theory for the entrepreneur (March 11, 2006, pp 68), much of which owes its genesis to Joseph Schumpeter. They note that traditional microeconomic theory holds a place for 'prices' and 'firms' but not for that (seemingly) important engine of innovation, the entrepreneur. Baumol is given credit for helping to remedy this shortcoming: "Thanks to Mr. Baumol's own painstaking efforts, economists now have a bit more room for entrepreneurs in their theories."
Baumol is a trustee of the Economists for Peace and Security.
1. Infrastructure and Economic Growth, p. 470
Question: Imagine a country with a “failed government” that can no longer enforce
the law. Contracts are not upheld and lawlessness is the order of the day. How could an economy operate and grow in this environment?
The point is to check that students can: understand how important the legal framework is to economic growth.
2. Ch. 16 T/F Quiz Friday, tomorrow.