Economics Classical and Keynesian Essay

1. Suppose during 2012 there is a sudden unanticipated bust of inflation. Consider the situations faced by the following individualswho gains and who loses? a. A home ask goter whose engage give stay fresh pace with inflation during the stratum, plainly whose periodic mortgage pays entrust remain fixed. This person has gained. tokenish income is income that you receive in a given time period and it is peakd in current dollars. authoritative income is titular income finded for inflation and is the purchasing power that your specie has. accepted income dictates the amount of goods and services the token(a) phrase income will buy. The homeowners noun phrase income has annexd (say 3%), scarce inflation has increased by the alike(p) amount (3%). The 3 percent increase in inflation reduces the 3 percent increase in nominal income, so the nominal income has non increased faster than inflation.The nominal income has kept pace with inflation. The homeowners gain is in regards to his fixed mortgage. Because his mortgage is fixed, it is immune to the inflation increase. If his nominal income in 2011 is $30,000 and his mortgage is $12,000 per year, he has $18,000 be to pay all some new(prenominal) expenses in 2011. If the homeowner receives a 3 percent raise, his nominal income for 2012 will be $30,900.00. His mortgage payment is fixed and will remain $12,000.00 per year. This leaves $18,900.00 of nominal income. When you reduce this nominal income by 3 percent to ad ripe for inflation, the homeowner has $18,333.00 of received income to pay for all other expenses in 2012. This is an increase of $333.00 from the year 2011 to 2012. This is non a huge increase, plainly this homeowner does gain. He dissolve purchase more goods and services in 2012 than he did in 2011. 2011 calculate2012 BudgetNominal income for 2011$30,000.00Nominal income for 2012 with 3% raise from 2011$30,900.00Mortgage in 2011$12,000.00Mortgage in 2012$12,000.00M maveny rem aining for other expenses$18,000.00Money remaining for all other expenses for the year 2012 before adjusted for inflation $18,900.00Subtracting 3% from $18,900.00 to adjust for inflation, the real number income per year is $18,333. This is the money remaining for all other expenses in 2012 $333 more than in 2011. $18,333.00b. An apartment landlord who has guaranteed to his tenants that their monthly rent payments will remain the same as it was in 2011. The landlord loses because he receives slight real income when inflation increases unexpectedly. The rent from his tenants becomes less than if prices had remained stable. The landlords income comes from the rent payments of the people keep in the building. If he collects $200,000 in 2011 from rent payments, his nominal income for 2011 is $200,000. If inflation is 3 percent in 2012, his real income decreases. strong income is nominal income adjusted for inflation. tercet percent inflation would reduce the nominal income by $6,000 . This persons real income would be $194,000. This is obviously less purchasing power than he had in 2011. Because the landlords nominal income stays the same and prices increase, his real income waterfall and his money has less purchasing power. He can buy fewer goods and services in 2012 than he did in 2011.The landlords nominal income has not risen faster than the rate of inflation and he ends up with a smaller share of total take. inflation causes a redistribution of income and wealth. The landlords income has been redistributed. Inflation has caused $6,000 of the landlords money to be redistributed to the tenants. The tenants will continue to purchase at least as many goods and services in 2012 as they did in 2011. The landlords real income will fall relation back to people whose nominal income increases with inflation. This income redistribution acts like a tax revenue. It takes income or wealth from one group and gives it to another. Those who come gained in this situa tion are the tenants whose rent will not increase, but the landlord loses. c. A retired individual who earns a pension with a fixed monthly payment from their past employer during 2015 This person has lost. His nominal income remains the same, but his real income decreases because ofinflation and his dollars have less purchasing power. He has less money in 2012 to purchase goods and services than he had in 2011 and his standard of animation decreases. He is able to purchase fewer goods and services than he could the earlier year because his nominal income has remained the same and his real income is less.His real income has fallen relative to those whose nominal income has increased. His nominal income does not keep pace with inflation and he ends up with a smaller share of total output. 2. Explain the dispute between REAL and NOMINAL gross domestic product. Which do you suppose would be the more authoritative taproom when looking at long limit sparing suppuration as shown in the Aggregate Supply/Demand work? Gross Domestic Product is the dollar value of all the output of goods and services produced in a year in a boorish. Nominal gross domestic product is that dollar value expressed in current prices. accepted GDP is nominal GDP adjusted for price increases (inflation). Nominal GDP is calculated apply current prices and real GDP is calculated using constant prices. Real GDP is an inflation-adjusted beatnik of physical output. Real GDP is the more important measure when looking at long term scotch growth. The rate of scotch growth measures the annual percentage increase in real GDP. Real GDP is the variable that is used to observe long-term growth in the thriftiness because it is the most comprehensive measure of sparing activity. The Aggregate Supply/Demand model focuses on the mien of twain variables, the economys output of goods and services, as measured by real GDP and the overall price level, as measured by the CPI. The output on the ho rizontal axis of the model is real GDP, which is the measure of the true value of annual national production.The amount of GDP output varies e really year and so does inflation. Therefore, how we measure real GDP growth must be adjusted to reflect inflation. If the economy of a country in 2000 allowed for output to reach $100 million and in 2001 the economy allowed for output to reach $110 million, it appears that the economy has grown by 10 percent but this is nominal GDP and has not been adjusted for inflation. When you adjust 2001s GDP for inflation, say 5%, the real GDP for 2001 is $ one hundred five million. The economy has actually grown by 5 percent and $5 million dollars. This is still a large number, but not as large as $10 million. If you use nominal GDP to measure long-term economic growth, you are not getting the true double of how much output has increased, or if it has actually fallen. If nominal GDP increases by 2 percent, but inflationincreases by 3 percent, output has actually declined by 1 percent. If you use nominal GDP, it could look like output has had a huge increase from year to year, but this gives a ill-considered measure. Nominal GDP has to be adjusted for changing price levels. Real GDP gives us an accurate reading of GDP because it measures output at constant prices.The more important measure of economic growth is reflected by dint of real GDP. 3. Classical and Keynesian economists retrieve in a unalike role for the government in dealing with recessions. Explain the differences between the two theories and the different roles. Classical and Keynesian economists see the role of the government other than when dealing with a recession. Classical economists believe in the ultraviolet bowl over and Keynesian economists believe in a helping gain. From the Classical decimal point of view, the economy is inherently stable. They believe there is an automatic mechanism (an invisible hand) that moves the commercialize toward equili brium and stability. The Classical guess is based on the pattern that the market can regulate itself when left alone. When output declines, it is only fugacious and the market will self-adjust. Classical economists believe the role of the government during a recession should be to leave the market alone (laissez faire). Government preventative can only bring the economy down and impede the market mechanism from working. In the long run, the good of the economy is best served if the government does not interfere. Classical economists believe that long-run growth is more important and piteous-run losses are acceptable. The Classical theorists believe that supply creates its own occupy (Says Law). If a good is produced, it will be purchased. Buyers and sellers just have to find a price acceptable to both.Classical economists believe that the economy is stimulated when more goods are produced. The concept of conciliatory prices is very important to the Classical theory. When pau perism slows, sellers can lower their prices to increase command and thus specify equilibrium. If subscribe to is too high, sellers can raise their prices to restore equilibrium. Flexible wages are besides important to the Classical theory. When psyche is unemployed, they can find another job by working for less money. Flexible wages guarantee that anyone who wants to work will work. Keynesian theory states that the economy is inherently unstable and needs a helping hand to find its equilibrium. This helping hand comes in the form of government hitch. Keynesian economists believe that the market is not capable ofachieving equilibrium by itself and it is practicable that disequilibrium will last for a long time. Keynes believed that small changes in output, prices, or employment were likely to be magnified, not corrected, by the invisible hand. He believed that the depression of the 1930s was not a unique event. He argued that a depression would happen again if we relied on th e market mechanism to self-regulate. He saw that macro failure was the rule, not the exception. In the Keynesian economic model, the government has the important role of smoothing out business cycle bumps to jibe economic growth and stability. Keynes believed in helping the economy in the short run, not the long run. When in a recession, the government should not appear to see when or if the market will self-correct.Keynes believed the government should intervene to make unnecessary jobs and income. Keynes saw that policy levers are both effective and necessary. Without such intervention the economy would experience repeated macro failures. The Keynesian perspective argues that an economy left alone will not reach its replete(p) capacity. strict intervention can come in the form of government consumption (increased or decreased), tax cuts, or tax increases. Also, Keynesian economists believe that if you demand it, it will be supplied. Keynesian theory maintains that most econo mies are demand driven and supply is based on demand. Keynesian theory believes in inflexible prices and wages. Prices do increase, but prices are not as flexible when going down. Suppliers must make a profit and will not supply at a loss. It is the same for wages. Wages do decrease, but they are much more inflexible when traveling in that direction. Keynes similarly saw that the economy does, at times, call for a budget shortfall or surplus. During a recession, the government can increase spending and/or lower taxes.This will cause the budget to run a deficit. Keynes also felt that when the economy is in good shape the debt should be paid. Debt payment can come in the form of spending cuts and/or tax increases. Keynes saw nothing wrong with an unbalanced budget when it was needed to keep the economy healthy and running smoothly. 3. Which do you believe is the relevant one in todays current economic downturn? Keynesian theory is the relevant theory in todays economic downturn. The market does need a helping hand. The economy can self-adjust, but the downturns can last for long periods and people suffer during these times. Without government intervention, an economic downturn can continue as it did in the 1930s. The government does havepolicy levers available that they can use to shift the aggregate demand and/or aggregate supply curves. These measures help restore the economy to its full production possibilities potential.