Karl Marx and Market Failure

Transcription

1 Unit 3 Karl Marx and Market Failure Krugman Module 74 pp ; Module 76 pp ; Module 77 pp ; Module 78 pp ; Module 79 pp Modules pp Greed is Good. -The Wealth of Nations Marx s Market Failures ASYMETRIC INFO MONOPOLY PUBLIC GOODS INEQUITY EXTERNALITIES BUSINESS CYCLES 3 Title goes here 1

2 Marx s Market Failures 4 Marx s Theory of the Business Cycle PEAK LEVEL OF REAL OUTPUT PEAK PEAK TROUGH TROUGH TIME Twin Problems of the Business Cycle Unemployment Inflation 5 JB Say Karl Marx Classical Economics Y = C Marxist Economics Y = C +S 6 Title goes here 2

3 The circular-flow diagram presents a visual model of the economy and Marx s theory of the causation of business cycles. First, the resource market (bottom loop) coordinates the actions of businesses demanding resources and households supplying them in exchange for income. Second, the goods & services market (top loop) coordinates the demand (consumption, investment, government purchases, and net-exports) for and supply of domestic production (GDP). Excessive saving creates postponed consumption or lost money which causes economic fluctuations. Marx s Circular Flow Diagram 7 8 Schumpeter s Response Joseph Schumpeter Y = C+S S=I Y = C+I 9 Title goes here 3

4 Schumpeter s Circular Flow Diagram Schumpeter creates a visual model of the economy coordinated by the four key markets: First, the resource market (bottom loop) coordinates the actions of businesses demanding resources and households supplying them in exchange for income. Second, the goods & services market (top loop) coordinates the demand (consumption, investment, government purchases, and net-exports) for and supply of domestic production (GDP). Third, the money market (lower center) brings the net saving of households plus the net inflow of foreign capital into balance with the borrowing of businesses and governments. 10 Aggregate Demand Curve The quantities of domestically produced goods & services that purchasers are willing to buy at different price s. AD is an inverse relationship between the amount of goods & services demanded and the price because: The Wealth Effect: A lower price will make people believe they are wealthier and encourage consumption. The Foreign Purchases Effect: A lower price will make domestically produced goods less expensive compared to foreign goods. The Interest Rate Effect: A lower rate of inflation will make the interest rate look lower causing more purchases. P1 P 2 Y1 Y2 A reduction in the price will increase the quantity of goods & services demanded. AD Goods &Services 11 Factors that Shift Aggregate Demand Taxes or Government Spending* Real Wealth. Expectations about future prices Debt of Consumers. AD 1 AD 0 AD 2 12 Title goes here 4

5 Short-Run Aggregate Supply Curve SRAS indicates the quantities of goods & services that domestic firms will supply in response to the price. SRAS curve slopes upward to the right. The upward slope reflects the fact that in the short run an increase in the price will improve the profitability of firms and they will respond with an expansion in output. P 105 P 100 SRAS (P100) An increase in the price will increase the quantity supplied in the short run. P 95 Y1 Y2 Y3 13 Shifts in Short Run Aggregate Supply Costs such as wages, rent, and interest. Unexpected supply shocks such as a change in weather or world price of an important resource. Taxes or Government Spending related to business and investment SRAS 1 SRAS 2 14 Aggregate Supply and Aggregate Demand AS (P 100) P Intersection of AD and AS determines output, employment, and price AD Goods &Services (employment) Y Short-run equilibrium in the goods & services market occurs at the price ( P ) where AD and AS intersect. If the price were lower than P, general excess demand in the goods & services markets would push prices upward. Conversely, if the price were higher than P, excess supply would result in falling prices. 15 Title goes here 5

6 Aggregate Supply of When considering the Aggregate Supply curve, it is important to distinguish between the short-run and the long-run. Short-run: -- businesses are only able to adjust production by adding more labor to fixed factory resources. Long-run: -- changes in the ability to produce, a shift in the Production Possibilities Frontier through Technology, Trade, or Resources. Long-Run Aggregate Supply Curve LRAS indicates the long run relationship between the price and quantity of output. LRAScurve is vertical. A higher price does not change the limits imposed by an economy's resource base, trade, or of technology. LRAS is the economy's production possibilities frontier. LRAS Y F (full employment rate of output) Change in price does not affect quantity supplied in the long run. Potential GDP Shifts in Long RunAggregate Supply LRAS 1 LRAS 2 Trade. Investment and Technology which results in increased productivity. More or less resources such as land and labor. Y F,1 Y F,2 Such factors as an improvement in technology will expand the economy s potential output and shift the LRAS to the right (note that SRAS will also shift to the right). Such factors as a reduction in resource prices, favorable weather, or a temporary decrease in the world price of an important imported resource would shift SRAS to the right (note that LRAS will remain constant). Title goes here 6

7 Changes in Real Interest Rates and Resource s Over the Business Cycle P R r s fall (because of weak demand ) Resource prices fall (because of high unemployment) Interest rates fall (because savings is greater than investment) LRAS r R P Interest rates rise (because investment is greater than savings) Resource prices rise (because of low unemployment) s rise (because of strong demand ) High Unemployment Low Inflation YF Low Unemployment High Inflation When aggregate output is less than the economy s full employment potential (Y F ), weak demand for investment leads to lower real interest rates, while slack employment in resource markets will place downward pressure on wages and other resource prices (P r ). Conversely, when output exceeds Y F, strong demand for capital goods and tight labor market conditions will result in rising real interest rates and resource prices (P r ). UNIT SUMMARY The circular flow describes the transactions in any economy. The circular flow shows both the real flow of products and resources, and the money flow of income, expenditures, revenue and costs. Marx described six flaws of the free market: asymmetric information, external costs, public goods, income inequity, imperfect competition, and business cycles. Each of Marx s market flaws means that the market has not achieved Socially Optimal Equilibrium. Marx s solution is government intervention. 21 Title goes here 7

8 UNIT SUMMARY Short-run fluctuations are part of the business cycle. Recessions are periods of deflation and high unemployment. Economists analyze fluctuations using the model of aggregate demand and aggregate supply. The aggregate demand curve slopes downward because of the wealth effect, an interest-rate effect, and an exchange-rate effect. The aggregate demand curve shifts due to Taxes, Real Wealth, Expectations, and Debt. The short-run aggregate-supply curve shifts in response to changes in costs, unexpected shocks, and taxes. The long-run aggregate supply curve is vertical because changes in the price do not affect output in the long run. Shifts in the long-run aggregate supply curve are caused by changes in resources, technology, or trade. 22 UNIT SUMMARY When aggregate demand falls, output, employment, and the price fall causing a surplus disequilibrium. In the long run, wages and interest rates fall, lowering costs, and the short-run aggregate supply curve shifts right. In the long run, the economy returns to the natural rates of output and unemployment, but with a lower price. When aggregate demand rises, output, employment, and the price rise causing a shortage disequilibrium. In the long run, wages and interest rates rise, raising costs, and the short-run aggregate supply curve shifts left. In the long run, the economy returns to the natural rates of output and unemployment, but with a higher price. 23 Title goes here 8