PRINCIPLES OF MACROECONOMICS PART IV Further Macroeconomics Issues TENTH EDITION CASE FAIR OSTER © 2012 Pearson Education, Inc Publishing as Prentice Hall Prepared by: Fernando Quijano & Shelly ofTefft 23 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc Publishing as Prentice Hall of 39 Alternative Views in Macroeconomics 18 CHAPTER OUTLINE Keynesian Economics Monetarism The Velocity of Money The Quantity Theory of Money Inflation as a Purely Monetary Phenomenon The Keynesian/Monetarist Debate Supply-Side Economics PART IV Further Macroeconomics Issues The Laffer Curve Evaluating Supply-Side Economics © 2012 Pearson Education, Inc Publishing as Prentice Hall New Classical Macroeconomics The Development of New Classical Macroeconomics Rational Expectations Real Business Cycle Theory and New Keynesian Economics Evaluating the Rational Expectations Assumption Testing Alternative Macroeconomic Models of 39 Keynesian Economics In one sense, Keynesian economics is the foundation of all of macroeconomics Now used more narrowly, Keynesian sometimes refers to economists who advocate active government intervention in the macroeconomy PART IV Further Macroeconomics Issues We begin with an old debate—that between Keynesians and monetarists © 2012 Pearson Education, Inc Publishing as Prentice Hall of 39 Monetarism The debate between monetarist and Keynesian economics is complicated because it means different things to different people If we consider the main monetarist message to be that “money matters,” then almost all economists would agree PART IV Further Macroeconomics Issues Monetarism, however, is usually considered to go beyond the notion that money matters © 2012 Pearson Education, Inc Publishing as Prentice Hall of 39 PART IV Further Macroeconomics Issues In the model of aggregate supply and aggregate demand, money matters because: a Changes in the money supply affect the AD curve b Changes in the money supply shifts affect the AS curve in the short run c Changes in the money supply shifts affect the AS curve in the long run d All of the above © 2012 Pearson Education, Inc Publishing as Prentice Hall of 39 PART IV Further Macroeconomics Issues In the model of aggregate supply and aggregate demand, money matters because: a Changes in the money supply affect the AD curve b Changes in the money supply shifts affect the AS curve in the short run c Changes in the money supply shifts affect the AS curve in the long run d All of the above © 2012 Pearson Education, Inc Publishing as Prentice Hall of 39 Monetarism The Velocity of Money velocity of money The number of times a dollar bill changes hands, on average, during a year; the ratio of nominal GDP to the stock of money PART IV Further Macroeconomics Issues The income velocity of money (V) is the ratio of nominal GDP to the stock of money (M): © 2012 Pearson Education, Inc Publishing as Prentice Hall V GDP M of 39 Monetarism The Velocity of Money We can expand this definition slightly by noting that nominal income (GDP) is equal to real output (income) (Y) times the overall price level (P): GDP P Y PART IV Further Macroeconomics Issues Through substitution: P Y V M or M V P Y quantity theory of money The theory based on the identity M × V ≡ P × Y and the assumption that the velocity of money (V) is constant (or virtually constant) © 2012 Pearson Education, Inc Publishing as Prentice Hall of 39 Monetarism The Quantity Theory of Money The key assumption of the quantity theory of money is that the velocity of money is constant (or virtually constant) over time If we let V denote the constant value of V, the equation for the quantity theory can be written as follows: PART IV Further Macroeconomics Issues M V P Y © 2012 Pearson Education, Inc Publishing as Prentice Hall 10 of 39 ... during a year; the ratio of nominal GDP to the stock of money PART IV Further Macroeconomics Issues The income velocity of money (V) is the ratio of nominal GDP to the stock of money (M): © 2012... curve in the long run d All of the above © 2012 Pearson Education, Inc Publishing as Prentice Hall of 39 Monetarism The Velocity of Money velocity of money The number of times a dollar bill changes... Education, Inc Publishing as Prentice Hall of 39 Monetarism The Quantity Theory of Money The key assumption of the quantity theory of money is that the velocity of money is constant (or virtually constant)