Schools of Economic Thought

Classical

  • Focuses on long run
  • Prices and wages are flexible
  • Output equals potential output; K and L fixed
  • No unemployment aside from frictional and wage rigidity unemployment
  • Classical dichotomy, “money is a veil”
    • Because of the dichotomy, monetary and fiscal policy don’t do anything
  • Famous Classical Economists: Adam Smith, David Ricardo
  • Neo-Classical: Ed Prescott, Bob Lucas

Keynesian

  • Focuses on short run but agrees with Classical Economics in the long run
  • Prices and wages are fixed/rigid
  • Output is demand-determined
  • Unemployment can be large and persistent
  • Money helps determine demand
    • As a result, monetary and fiscal policy directly influence output and demand
  • Keynesians: John M Keynes, John Hicks, James Tobin
  • Neo-Keynesians: Greg Mankiw, David Romer

Monetarist

  • Believes that short-run fluctuations are determined by the Quantity Theory of Money (Classical Economics is right in the long run)
  • Prices and wages are partially fixed in the short run
  • Fiscal policy is not very effective, but monetary policy is
  • Monetarists: Irving Fisher, Milton Friedman

Austrian

  • Classical Economics is right in the long run, but there are cycles of optimism and pessimism
    • Booms lead to over-optimism and over-investment which leads to recessions
    • Recessions lead to pessimism and under-investment which leads to booms
  • Cyclical nature of booms and downturns; Each boom “sows the seeds of the next crisis”
  • Recessions are necessary to flush out bad investments, so fiscal and monetary policy are harmful in getting rid of bad investments
  • Austrians: Ludwig von Mises, Friedrich Hayek

Marxist

  • Labor Theory of Value: the value of a good is how much labor it takes to produce
    • Flawed theory
  • Economy is divided into laborers and capitalist
  • Labor is abundant, earns a subsistence wage
  • Capitalists have monopsony power in labor market, so they can pay subsistence wages and take the remaining surplus for themselves
    • Real wage is not equal to marginal product of labor due to monopsony
  • Marxists: Karl Marx, Friedrich Engels

Okun’s Law

  • On average, GDP grows at 3% per year and unemployment would be unchanged
  • When unemployment falls, GDP grows more than expected, and vice versa
    • Slope: -2%; for every one percent increase in unemployment rate, GDP growth falls by two percent

Bonds

  • A bond is a loan to a company; has seceral components
    • Face value: How much the loan is for
    • Maturity: when the loan must be paid back
    • Coupon payments: payments expressed as a percentage of the bond that must be paid over the course of the bond
    • Current price is the current price of the bond, not how much you get when it matures
    • Bond yield is the entirety that you get from the coupon rate and the price
    • Bond yield can be less than the coupon rate if the current price is larger than the face value