Economics Classical and Keynesian
The landlord loses because he receives less real income when inflation increases unexpectedly. The rent from his tenants becomes less than if prices had remained stable. The landlord’s income comes from the rent payments of the people living in the building. If he collects $200,000 in 2011 from rent payments, his nominal income for 2011 is $200,000. If inflation is 3 percent in 2012, his real income decreases. Real income is nominal income adjusted for inflation. Three percent inflation would reduce the nominal income by $6,000. This person’s real income would be $194,000.
This is obviously less purchasing power than he had in 2011. Because the landlord’s nominal income stays he same and prices increase, his real income falls and his money has less purchasing power. He can buy fewer goods and services in 2012 than he did in 2011. The landlord’s nominal income has not risen faster than the rate of inflation and he ends up with a smaller share of total output. Inflation causes a redistribution of income and wealth. The landlord’s income has been redistributed. Inflation has caused $6,000 of the landlords’ money to be redistributed to the tenants.
The tenants will continue to purchase at least as many
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His nominal income remains the same, but his real income decreases because of inflation and his dollars have less purchasing power. He has less money in 2012 to purchase goods and services than he had in 2011 and his standard of living decreases. He is able to purchase fewer goods and services than he could the previous year because his nominal income has remained the same and his real income is less. His real income has fallen relative to those whose nominal income has increased. His nominal income does not keep pace with inflation and he ends up with a smaller share of total output. 2. Explain the difference between REAL and NOMINAL GAP.
Which do you suppose would be the more important measure when looking at long term economic growth as shown in he Aggregate Supply/Demand model? Gross Domestic Product is the dollar value of all the output of goods and services produced in a year in a country. Nominal GAP is that dollar value expressed in current prices. Real GAP is nominal GAP adjusted for price increases (inflation). Nominal GAP is calculated using current prices and real GAP is calculated using constant prices. Real GAP is an inflation-adjusted measure of physical output. Real GAP is the more important measure when looking at long term economic growth.
The rate of economic growth measures the annual percentage increase in real GAP. Real GAP is the variable that is used to monitor long-term growth in the economy because it is the most comprehensive measure of economic activity. The Aggregate Supply/Demand model focuses on the behavior of two variables, the economy’s output of goods and services, as measured by real GAP; and the model is real GAP, which is the measure of the true value of annual national production. The amount of GAP output varies every year and so does inflation. Therefore, how we measure real GAP growth must be adjusted to reflect inflation.
If the economy of a country in 2000 allowed for output to reach $100 million and in 001 the economy allowed for output to reach $110 million, it appears that the economy has grown by 10 percent; but this is nominal GAP and has not been adjusted for inflation. When you adjust sass’s GAP for inflation, say 5%, the real GAP for 2001 is $105 million. The economy has actually grown by 5 percent and $5 million dollars. This is still a large number, but not as large as $10 million. If you use nominal GAP to measure long-term economic growth, you are not getting the true picture of how much output has increased, or if it has actually fallen.
If nominal GAP increases y 2 percent, but inflation increases by 3 percent, output has actually declined by 1 percent. If you use nominal GAP, it could look like output has had a huge increase from year to year, but this gives a false measure. Nominal GAP has to be adjusted for changing price levels. Real GAP gives us an accurate reading of GAP because it measures output at constant prices. The more important measure of economic growth is reflected through real GAP. 3. Classical and Keynesian economists believe in a different role for the government in dealing with recessions.
Explain the preferences between the two theories and the different roles. Classical and Keynesian economists see the role of the government differently when dealing with a recession. Classical economists believe in the invisible hand and Keynesian economists believe in a helping hand. From the Classical point of view, the economy is inherently stable. They believe there is an automatic mechanism (an invisible hand) that moves the market toward equilibrium and stability. The Classical theory is based on the principle that the market can regulate itself when left alone.
When output declines, it is only temporary and the market will self-adjust. Classical economists believe the role of the government during a recession should be to leave the market alone (laissez fairer). Government intervention can only bring the economy down and impede the market mechanism from working. In the long run, the good of the economy is best served if the government does not interfere. Classical economists believe that long-run growth is more important and short-run losses are acceptable. The Classical theorists believe that supply creates its own demand (Says Law).
If a good is produced, it will be purchased. Buyers and sellers Just have to find a price acceptable to both. Classical economists believe that the economy is stimulated when more goods are produced. The concept of flexible prices is very important to the Classical theory. When demand slows, sellers can lower their prices to increase demand and thus restore equilibrium. If demand is too high, sellers can raise their prices to restore equilibrium. Flexible wages are also important to the Classical theory. When someone is unemployed, they can find another Job by working for less money.
Flexible wages guarantee that anyone who wants to work will work. Keynesian theory states that the economy is inherently unstable and needs a helping hand to find its equilibrium. This helping hand comes in the form of government intervention. Keynesian economists believe that the market is not capable of achieving equilibrium by itself and it is possible that disequilibrium will last for a likely to be magnified, not corrected, by the invisible hand. He believed that the depression of the asses was not a unique event. He argued that a depression would happen again if we relied on the market mechanism to self-regulate.
He saw that macro failure was the rule, not the exception. In the Keynesian economic model, the government has the important role of smoothing out business cycle bumps to ensure economic growth and stability. Keynes believed in helping the economy in the short run, not the long run. When in a recession, the government should not wait to see when or if the market will self-correct. Keynes believed the government should intervene to save Jobs and income. Keynes saw that policy levers are both effective and necessary. Without such intervention the economy would experience repeated agro failures.
The Keynesian perspective argues that an economy left alone will not reach its full capacity. Corrective intervention can come in the form of government spending (increased or decreased), tax cuts, or tax increases. Also, Keynesian economists believe that if you demand it, it will be supplied. Keynesian theory maintains that most economies are demand driven and supply is based on demand. Keynesian theory believes in inflexible prices and wages. Prices do increase, but prices are not as flexible when going down. Suppliers must make a profit and will not supply at a loss.
It is the same for wages. Wages do decrease, but they are much more inflexible when traveling in that direction. Keynes also saw that the economy does, at times, call for a budget deficit or surplus. During a recession, the government can increase spending and/or lower taxes. This will cause the budget to run a deficit. Keynes also felt that when the economy is in good shape the debt should be paid. Debt payment can come in the form of spending cuts and/or tax increases. Keynes saw nothing wrong with an unbalanced budget when it was needed to keep the economy healthy and running smoothly. 3.
Which do you believe is the relevant one in today’s current economic downturn? Keynesian theory is the relevant theory in today’s economic downturn. The market does need a helping hand. The economy can self-adjust, but the downturns can last for long periods and people suffer during these times. Without government intervention, an economic downturn can continue as it did in the asses. The government does have policy levers available that they can use to shift the aggregate demand and/or aggregate supply curves. These measures help restore the economy to its full production possibilities potential.