Reading Guide 8

Textbook Reading Guide – Unit 8 Classical/Neoclassical

Jim’s comments:  

Read Chapter 13. The textbook goes from the AD-AS model introduction (the last unit) to the Keynesian Model, and then to the Neoclassical model.  I, however, think this is a backwards way of dealing with it.  So we’re going to skip chapter 12 for the moment (we’ll go it next unit) and read Chapter 13 on Neoclassical theory.

A note on Phillips curve and expectations:
In section 13.1, the author spends some time explaining how “expectations of inflation” affect the Phillips curve. We haven’t really studied the Phillips Curve yet since it is introduced in the chapter on Keynesian theory.  The short version of the Phillips curve is the idea that there is trade-off between inflation (rising prices) and growth/employment. In essence, when an economy grows so much or so fast that it’s at full employment or “capacity”, meaning everybody who can be employed  is employed, attempts to stimulate more buying or more demand will only result in rising prices (inflation).  A major implication of a Phillips curve-type trade-off between inflation and employment/spending, is that when there is high unemployment (low employment with many unemployed workers), then increased government spending will not be inflationary. Increased government deficit spending won’t increase inflation until capacity (LRAS)/ full employment is reached.

The behavior of real economies in the 2oth and early 21st centuries have behaved a lot like the Phillips curve illustrates. This was devastating to Classical theory. Many economists, for ideological and methodological reasons, refused to abandon Classical theory.  Instead they evolved an idea of “expectations of inflation” as a way to negate the power of the Phillips curve trade-off. This resulted in Neoclassical theory, which as it’s name implies, is an “updated” or “newer” version of the older Classical theory.  Don’t be too concerned with the portion of section 11.1 that explain the “expectations-augmented” Phillips curve.

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Table of Contents from Principles of Macroeconomics, 2e