The Basics of Keynes's Monetary Theory - Essay Example

 Economics Part 1 Without a doubt, John Keynes contribution to economics among other economists is acknowledged through his general theory on employment, interest and money. More significantly, Keynes focused on the significance of government intervention in the control of the Laissez-faire economy that could control the effects of inflation and unemployment in the economy. More so, Keynes focused on the use of public policy through both the monetary and fiscal policies through the government. This includes the use of increased government spending rather than reduction in wage rate to influence the reduction in unemployment. In addition, Keynes cautioned against free market systems as he pointed it out to be the cause of unexpected rampant increase in unemployment rates. As Keynes differed with the classical perspective of economists on employment he keenly explained that employees were interested on the nominal wage rather than real wage. Keynes further describes how employees respond to the levels of unemployment based on prices of wages in terms of frictional, seasonal and voluntary unemployment. Keynes biggest contribution is based on the money illusion by workers that lead to involuntary unemployment. In addition, Keynes came up with the liquidity preference theory of interest rates that focuses on uses of money in differences classes. This is because money could be held for transaction motive as individual wish to make normal purchases besides money for precautionary motive that is for unforeseen incidences and money for speculative motive of investments to get returns. In addition, the government can control the amount of money borrowed from financial institutions by increasing the interest rate during periods of high inflation. Both the New Keynesian economists and New Classical economists have made contributions to the field of economics in the twentieth century. As a group opposed to the Keynes theory perspective, the new classical group of differs as they point out that Keynes did underestimate the impact of the quantity of money on aggregate demand and prices in the economy. In addition, the new classical economists argue a different notion on unemployment and inflation (Meltzer, 2005). This is because they advocate for a stable inflation-unemployment trade-off through the Phillips curve that involves the assumption of changes in the price level in the private sector freely. In addition, this class of economists conceptualized that the expectations-augmented in the Phillips curve could reduce the unemployment rate to a further extent below its natural level leading to higher levels inflation in the long run (Meltzer, 2005). The new classical economists differ with the Keynes economists as they believe both monetary and fiscal policy lead to increased inflation rates because the response of suppliers to economic market. Based on classical assumption on flexible prices a consecutive increase in aggregate demand automatically leads to higher prices; that cause unexpected shift as suppliers will increase production to take advantage of increased relative prices. The New Keynesian economists are based on the theory contributions made by Keynes as they believe that in the economy the nominal variables can affect real variables and understanding of market imperfections in the economy. This new group of Keynes economists believes that imperfect competition will solve several problems that deal with wages and prices levels thus, reducing the possibility of involuntary unemployment (Meltzer, 2005). This new class of Keynes economists believes that the welfare of the citizen is in increasing output and employment. Therefore, this class of economists believes that both monetary and fiscal policy allows for changes in price levels as it affects both the demand and supply. Part 2 Population is 500,000 Production local = 100,000 cars per year People who purchase cars = 90,000 Imports = 50,000 Government spending = 25,000 for police force and 10,000 for companies giving a total of 35,000 cars Exports = 65,000 cars Country’s A GDP Gross Domestic Product (GDP) = C + I + G + (X-M) Y = 90,000 + 100,000 + 35,000 + (50,000- 65,000) Y = 225,000 – 15,000 = 210,000 Composition of GDP by percentage (Mankiw, 2012) Investment = 100,000/ 210,000 = 47.62 % Consumption = 90,000 / 210,000 = 42.86% Import = 50,000/ 210,000 = 23.81% Government spending = 35,000/ 210,000 = 16.67% Export = 65,000/ 210,000 = 30.95% GDP per Capita = Gross Domestic Product/ national population GDP per Capita = 210,000/500,000 = 0.42 When the government purchase in the short run increases the aggregate level of demand shifts to the right thus, leading to increase in the gross domestic product. This is because as illustrated in the figure below the initial equilibrium level at point P1 shifts towards point P2 leading to increase in the real gross domestic product in the economy from Y1 to Y3 in the short run. Figure 1(Mankiw, 2012) Nonetheless, when both the consumption and government purchases level go up in the economy, the price levels remain constant give an upward increase in the gross domestic product in the long run. As a result, the price levels remain constant at P3 because the long run aggregate supply level is price inelastic while the aggregate demand shifts rightward leading to an increase in real gross domestic product from Y1 to Y3 as illustrated in the figure above (Mankiw, 2012). More than often, the government purchases and consumption levels changes are determined by Keynesian economics because they both relate to public policy through monetary and fiscal policies. This is because, consumption and government expenditures are normally financed through debt and an increase in the price levels causes the interest rates to go up because more individuals in the economy will try to hold cash ( Mankiw, 2012). These features of changes in interest rates, government purchases, and consumption levels relate to Keynesian economics theory. Part 3 Real Gross Domestic Product in the first quarter of 2012 is 15,094 billion and the nominal gross domestic product (GDP) is 3,646.6 billion. The difference between difference between nominal and real GDP is (15,094 - 3,646.6 =11447.4) .The largest component of gross domestic product (GDP) is in the manufacturing and retail sector. This is because there was an increase in the trading of petroleum and coal products as manufacturing products. On the other hand, the smallest component of the gross domestic product (GDP) is in the motor vehicles, bodies, trailers, and parts contribution to the country economy (U.S department of commerce Bureau of Economic analysis, 2012). Nonetheless, the fastest growing component of GDP is that of the manufacture of petroleum and coal products showing a steady increase over the yearly quarters. The components of GDP were involved in the change in imports, exports and private inventories. The price index as a measure of chain-type is currently at 2.5%. Changes in the price index were as a result, of consumption, export, import, and investment levels. The gross domestic product (GDP) and the CPI index are totally different (U.S department of commerce Bureau of Economic analysis, 2012). Nonetheless, the gross domestic product (GDP) index is sensible as it gives an overview. References Mankiw, N. (2012). Brief principles of macroeconomics. Mason, OH: South-Western Cengage Learning. Meltzer, A. (2005). Keynes's Monetary Theory A Different Interpretation. London: Cambridge University Press. U.S department of commerce Bureau of Economic analysis (2012, April 18). U.S economic accounts. Retrieved April 19, 2012 from http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp4q11_3rd.pdf. Read More