Macroeconomics Simplified: Understanding Keynesian and Neoclassical Macroeconomic Systems

223 Pages·2014·5.15 MB·English

by  Nicoli Nattrass

Macroeconomics Simplified

Macroeconomics Simplified
Understanding Keynesian and
Neoclassical Macroeconomic Systems
Nicoli Nattrass
G. Visakh Varma
Copyright © Nicoli Nattrass and G. Visakh Varma, 2014
All rights reserved. No part of this book may be reproduced or utilised in any form or by any means,
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system, without permission in writing from the publisher.
First published in 2014 by
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Library of Congress Cataloging-in-Publication Data
Nattrass, Nicoli.
Macroeconomics simplified : understanding Keynesian and neoclassical macroeconomic systems / Nicoli
Nattrass, G. Visakh Varma.
pages cm
Includes bibliographical references and index.
1. Macroeconomics. 2. Neoclassical school of economics. I. Varma, G. Visakh. II. Title.
HB172.5.N336 339—dc23 2014 2014014629
ISBN: 978-81-321-1772-8 (PB)
The SAGE Team: Sachin Sharma, Saima Ghaffar, Rajib Chatterjee and Dally Verghese
Dedication
This book is dedicated to the memory of Visakh’s parents,
K. R. Goda Varma and Malathi Goda Varma, and Nicoli’s mother, Jill Nattrass.
Thank you for choosing a SAGE product! If you have any comment,
observation or feedback, I would like to personally hear from you.
Please write to me at [email protected]
—Vivek Mehra, Managing Director and CEO,
SAGE Publications India Pvt. Ltd, New Delhi
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
CONTENTS
List of Tables xi
List of Figures xiii
Acknowledgements xvii
1. Introduction 1
Technical and Ideological Issues 3
2. The National Accounts 5
National Income Accounting Concepts 5
Expenditure on the GDP 7
Other Macroeconomic Aggregates 10
The GNP at Market Prices 11
A Few Identities 11
Real and Nominal GDP 12
The GDP, Economic Development and Welfare 13
The GNP and Welfare 15
Review Questions and Answers 18
3. The Neoclassical Macro Model 19
The Classical Dichotomy and the Homogeneity Postulate 20
The Determination of Employment and Output 21
The production function 21
The demand for labour function 22
The supply of labour function 24
Equilibrium in the labour market 25
viii Macroeconomics Simplified
The Determination of Output and Employment 26
The aggregate supply (AS) function 26
Say’s law 31
The Quantity Theory of Money 34
New Classical Stories about the Business Cycle 36
Review Questions and Answers 38
4. The Simple Keynesian Model 40
The General Theory 41
The Principle of Effective Demand and Keynes’s Economics 44
Quantity Adjustment 48
The ‘Keynesian Cross’ Model of Income Determination 49
New Keynesian Microfoundations 58
The Relevance of Keynesian Economics Today 60
Review Questions and Answers 62
5. Investment and Interest Rates 63
Interest Rates and Investment 63
Bond Prices and Yields: Some Basics 65
The Relationship between Investment and the Interest Rate 66
Inflation and Interest Rates 70
The Structure of Interest Rates 71
The Term Structure of Interest Rates 72
The Expectations Theory of the Yield Curve 72
Inflation-indexed Bonds in India 76
Review Questions and Answers 77
6. The IS–LM Model 79
The Role of Investment 80
The IS Curve with No Government Sector 81
Equilibrium in the goods market: The IS curve 81
Planned investment and savings 82
Deriving the IS curve 83
Deriving the simple IS curve geometrically 86
Shifts of the simple IS curve 88
The IS curve including government 90
The Balanced Budget Multiplier 92
Deriving the IS Curve (Including Government) Geometrically 93
Shifts in the IS curve 95
Positions on and off the IS curve 95
Movements along the IS curve 97
The Financial Sector (The LM Curve) 97
Demand for money in the IS–LM model 98
Contents ix
Money market equilibrium 101
Deriving the LM curve 101
Deriving the LM curve geometrically 102
Points on and off the LM curve 103
Movements along the LM curve 106
Shifts of the LM curve 106
Equilibrium in the Goods and Money Market 108
Comparing the Keynesian Cross and the IS–LM Models 111
Review Questions and Answers 113
7. Fiscal and Monetary Policies in the IS–LM Model 118
Fiscal and Monetary Policies in a Keynesian Framework 120
Fiscal policy 120
Monetary policy 121
Dynamic adjustment and economic policy 122
Fiscal and Monetary Policies in a Neoclassical Framework 125
Fiscal policy 127
Monetary Policy 129
A Pragmatic Approach to IS–LM 131
Distribution and Demand 133
Investment and Economic Policy 135
Review Questions and Answers 139
8. The Aggregate Supply and Demand Model 140
The AS Curve 141
The neoclassical AS curve 141
Deriving the AS curve with money wages rigid downwards:
The ‘Keynesian’ version 142
The Aggregate Demand (AD) Curve 145
Shifting the AD curve 146
Equilibrium in the Keynesian AS–AD Model 148
The dampening effect of prices on the multiplier 149
Interpreting the Keynesian less than full-employment equilibrium 150
Equilibrium in the Neoclassical AS–AD Model 152
Comparing the One-sector, Two-sector and Three-sector Keynesian Models 153
Short-term and Long-term Growth 155
The Phillips Curve and Unemployment 156
The Phillips curve 156
The Relationship between Wage Growth and the Rate of Unemployment
in a Closed Economy 157
A Dynamic Keynesian Model Assuming Naive Expectations 158
Adaptive Expectations and the Long-run Vertical Phillips Curve 161
Rational Expectations 162