LONG RUN, MACROECONOMICS: In terms of the macroeconomic analysis of the aggregate market, a period of time in which all prices, especially wages, are flexible, and have achieved their equilibrium levels. This is one of two macroeconomic time designations; the other is the short run. Long-run wage and price flexibility means that ALL markets, including resources markets and most notably labor markets, are in equilibrium, with neither surpluses nor shortages. Wage and price flexibility and the resulting resource market equilibria are the reason for the vertical long-run aggregate supply curve.
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Scientific theories that seek to explain phenomena associated with the macroeconomy. The primary phenomena investigated are unemployment, inflation, and the level of aggregate production. Macroeconomic theories also inevitably provide policy recommendations intended to improve the performance of the economy and to correct macroeconomic problems. A few of the more noted macroeconomic theories are: Classical economics, Keynesian economics, aggregate market (AS-AD) analysis, IS-LM analysis, Monetarism, and New Classical economics. Macroeconomic theories are scientific theories that have been devised to provide insight into the workings of the macroeconomy. They are primarily designed to explain how and why the level of gross domestic product changes, but they usually have direct implications for unemployment and inflation, as well. Most theories offer insight into other dimensions of the economy, such as interest rates, consumption expenditures, the price level, investment expenditures, saving, and taxes.
A Short ListA number of macroeconomic theories have been developed over the decades. They are often aimed at addressing pressing economic problems of the day. In that the pressing economic problems tend to be unemployment, inflation, or stagnant growth, most macroeconomic theories make a concerted effort to shed light on these issues.
- Classical Economics: The granddaddy of macroeconomic theories stems from the groundbreaking work of Adam Smith, the father of modern economics. This theory is based on the notion that flexible prices ensure market equilibrium such that full employment production is maintained. The primary policy implication is that government intervention is not needed to maintain economic stability.
- Keynesian Economics: Developed by its namesake, John Maynard Keynes, this theory was in response to the massive unemployment problems of the Great Depression of the 1930s. It rests on the presumption that aggregate demand for production is the primary source of business-cycle instability. The primary policy implication is that economic instability runs rampant without government intervention.
- Aggregate Market (AS-AD) Analysis: This theory is a synthesis between Classical economics and Keynesian economics that was created to help explain stagflation (high rates of both unemployment and inflation) that emerged in the 1970s. It represents the current, state-of-the-art macroeconomic theory. As such, it illustrates the how and why of policy implications found separately in Classical economics and Keynesian economics.
- IS-LM Analysis: This theory is a more advanced version of Keynesian economics that integrates the product market (the IS part of IS-LM) with the money or financial market (the LM part of IS-LM). In so doing, it provides insight into the role money and interest rates play in macroeconomic activity. It represents a step along the way between the Keynesian economics and the development of aggregate market (AS-AD) analysis.
- Monetarism: Championed by Nobel Prize winner Milton Friedman, this theory places the quantity of money that circulates around the economy at the center of macroeconomic instability. Many of the key features of Monetarism are incorporated in by IS-LM analysis and aggregate market (AS-AD) analysis.
- New Classical Economics: This theory emerged in the 1970s as a rebirth of Classical economics. It contends that people have rational expectations about the consequences of government policies, which then negates the impact of the policies. As such, like Classical economics, the primary implication is the economy maintains full employment without the need for government intervention.
Theories in MotionThe scientific method is a process of discovery. One theory is developed, tested, and scrutinized. If it does not satisfactorily explain real world phenomena, then it is modified and tested again. If it consistently fails to explain phenomena or if many flaws in the theory are reveal, then it is discarded for another theory.
Nowhere in the world of science is this process more evident than macroeconomics. Alternative macroeconomic theories have been proposed and scrutinized. Some of have been tossed into the trash can of economic analysis. Most have been modified, often integrated with other theories to form stronger, more comprehensive theories.
Adam Smith launched the modern study of economics in the late 1700s. Over the ensuing 150 years, his basic theory of markets was modified, refined, and eventually applied directly to the study of the macroeconomy in the form of what is now termed Classical economics.
However, when it did not adequately predict or explain the Great Depression of the 1930s, Keynesian economics was developed. This theory went through decades of testing, modification, and refinement as well. Along the way, Monetarism offered an alternative view of the macroeconomy, which contributed to the creation of IS-LM analysis.
Keynesian economics, though, fell short of satisfactorily explaining the simultaneous occurrence of high rates of unemployment and high rates of inflation of the 1970s. This led to a surge of alternative theories, including the rebirth and improvement of Classical economics in the form of New Classical economics. This theory was then synthesized with Keynesian economics to create the aggregate market (AS-AD) analysis.
And on it goes....
Pervasive PoliticsMacroeconomic theories are intertwined with politics. Because macroeconomic theories are inevitably developed to address, explain, and offer remedies for macroeconomic problems such as unemployment and inflation, they also inevitably generate specific policy recommendations. Particular policies often appeal to particular political views. As such, the particular political views also tend to embrace the underlying theories.
For example, New Classical economics and its policy implications of limited government intervention mesh nicely with a conservative political philosophy that the best government is the least government. Alternatively, Keynesian economics and its policy implications of needed government intervention fits well with a liberal political view that government is the solution to society's problems.
The close connection between politics, policies, and macroeconomics means that the development of macroeconomic theories often depends as much on prevailing political attitudes as on scientific scrutiny.
MACROECONOMIC THEORIES, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: February 27, 2024].
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Okun's Law posits that the unemployment rate increases by 1% for every 2% gap between real GDP and full-employment real GDP.
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