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 FRIEDMANFriedrich 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 THEORYKeynesian 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 THEORYThis 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 EconomymyMaking 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