Step 18: Schools of Economics

Three Schools of Economics

Classical

Names to know:

• Adam Smith
• John B. Say
• David Ricardo
• Alfred Marshal

-competition is good

-Smith: invisible hand - market will function by itself

-Say's Law - supply creates its own demand = AS determines output

-In the LR, the economy will balance at full employment

-The economy is always close to or at full employment

-AS = AD at FE equilibrium

-Trickle-Down Effect: Help the rich first, everyone else come after

-Savings (leakage) = Investment (injection)

-Savings increase with interest rate

-Prices and wages are flexible downward

-Laissez-faire: government can't touch the economy

Keynesian

Name to know:

• John Maynard Keynes

-competition is flawed

-AD is key, not AS = AD determines output; demand creates its own supply

-Leaks cause constant recessions; savings cause recessions

-Savers and investors save and invest for different reasons

-Savings = Inverse to Interest Rate

-Ratchet Effects and Sticky wages block Say's Law

-Prices and wages are inflexible downward

-Since no mechanism capable of guaranteeing FE, in the LR, we're all dead

-Economy is not always close to or at FE

-Gov't interventions exist
-Use Fiscal Policy (Expansionary and Contractionary)
-Add stabilizers

Monetary

Names to know:

• Allen Greenspan
• Ben Bernanke

-fine tuning needed

-voters won't allow contractionary options

-Congress can't time policy options

-easy money and tight money
-change required reserves if needed

-buy sell bonds through open market operations

-use interest rate to change the discount and federal fund rate