05/03/2021

Keynesian’s Economics

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Background

• Great Depression, Black Thursday, 24 October 1929 • Situation: overheated asset price and tight money policy. • The falldown of stock value. After first 10 months 744 banks failed. In 1933, 4000 banks failed. Depositors lost $140 billion • The stock market lost 90% of its value between 1929 and 1932. People lost all confidence in Wall Street • High unemployment, from 3,2% in 1929 to 25% in 1930 • Housing price fall down 67% • International Trade reduce 65% • Deflation, betweein 1930 and 1932, price fell 30% 1930 : -6.4% , 1931: -9.3% , 1932 : -10.3%

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John Maynard Keynes

• Books, “Genral Theory”, Anti-thesis of classical economics • Market is imperfect • Market forces produces undesirebale outcome such as deep depression • Price does not adjust quickly • Give policy makers guidance how out of recession and facing unpredictable financial market • General Theory is the response to economic situation ata that time • Full employment by neoclassic is special case, Keynes unemployment equilibrium is general case • When crisis, income can be hoarded and high risk, AD will fall • Level of employment depend on demand (actual spending and the xpectation)

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Short-run

• Sticky Price/ Price Rigidity (not all products) : price is difficult to adjust when recession happen such as wages, restaurant menu, manufacture products, interest rate. Keynesians believe that prices, and especially wages, respond slowly to changes in supply and demand, resulting in periodic shortages and surpluses. • Why Sticky ? Companies need to cover all cost like before recession situation. New price need more cost (advertising, raw material, production, positioning, etc) • Raw products (commodities) easy to adjust such as food (rice, wheat, onion, beans), mining (oil, gold, coal), plantation (cotton, crude, palm oil, rubber) • Sticky price create macroeconomic externality, what happen at macro level is different at the micro level. The sales of products hard to rebound due to rigidity.

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Keynes AD-AS

AD always fluctuate

Suppose economy at the level price of P0 and Potential GDP at Yp. And then, there

was change, AD reduce from AD0 to AD1. Low af AD reduce consumption, investment and production will reduce income from Yp to Y1. Its called recessionary gap. Eventhough GDP reduce but price didn’t reduce (sticky) Yp has full employment but Y1 create unemployement. Axis Y  Price Level Axis X  Real GDP AD increase, price easy to go up. The economy Real GDP : in inflationary gap. Demand push the the amount of goods and servicesthat economy pas potential output. actually sell Policy Implication : Potential GDP (Yp) : Recession  govt increase spending The estimation of the output taht Inflation  govt decreasing spending economy would produced (if labor and capital had been employed)

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Q2 Q2

In the beginning, economy equilibrium The reduction of aggregate demand from at E0. And then, aggregate demand fall D0 to D1, impact to demand of goods down from D0 to D1. It’s impact to from Q0 to Q2. The reduction of demand demand of labor from Q0 to Q2 (if wages is not followed by reduction of price. The reduce). But, the wages is sticky. It’s price is not reduce and still at P0. The make more burden for companies. reduction of goods demand increase to Demand of labor reduce more to Q1. Q1 and create excexx supply (Q1-Q0) Its create excess suplpy of labor (unemployment)

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AD in the Short-Run

Aggregate Demand 1. Consumption Output (households) 2. Investment (companies) 3. Government Employment Spending

Aggregate Demand (AD): total money spending in economy, incurred by households, companies and government.

When economy in recession, demand is weak. Households consumption fall down. If demand low, companies don’t want to invest. In order to stimulate economy, government must increase spending . Government spending will stimulate AD to increase output (production) and create jobs (employment)

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Government’s Role • The duty of government to counter the failings of market processes through economic policy

Govt Govt Projects Employment IIncome Stimulus (dam, road, railway) (wages for employee)

Economic Private Private Consumption Growth Investment Production (wages for food, clothes, etc)

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Keynesian Cross

1. Actual Expenditure (AE) The amount of households, firms, and government spend on goods and services (GDP). 2. Planned Expenditure (PE) Amount of households, firms and government would like to spend on goods and services AE and PE are often not meet each others. Firms face unplanned invenstory investment because their sales do not meet expectation. All production can not absorb by market, so there are still goods in stock (warehouse). Stock increase. I firms sell more than planned their stock of inventories falls. AE can be either above or below palnned expenditure

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US Growth (%)

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20 18.9 17.7 17 15 12.9 10.8 10 8.9 8 8.8 8 5

5,1 -3,3 0 -1.2 -1 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 -5 -6.4 -10 -8.5 -12.9 -15

New Deal boost GDP growth by 10.8% in Preparations for WW II increase growth 1934. Govt cut back new deal spending in 8% in 1939 and 8.8% in 1940. The next 1938, depression returned and the year Japan attacked Pearl Harbor and economy growth become -3.3% WWII started

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US Unemployment Rate (%)

30

25 24.9 23.6 21.7 20 20.1 19 16.9 17.2 15.9 15 14.3 14.6

10 9.9 8.7 6.6 5 4.7 3.2 3.9 3.6 4 1.9 1.2 1.9 0 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949

The unemployment is lagging Recession and depression cause high indicators. When economy begins to unemployment. Businesses lay off workers improve after recession, the and jobless workers have less to spend as unemployment rate may continue to result. Low demand reduces business worsen for sometime. Many companies revenue. From 1931 to 1940, hesitate to hire workers until they unemployment rate above 14% regain confidence in recovery.

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Relationship Growth and Unemployment (%)

30 25 20 15

10 Growth 5 Unemploy 0 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 -5 -10 -15

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