DETERMINATION OF ECONOMIC ACTIVITIES
Views of Classical Economists • Opinions of classical economists, in an economy governed by market mechanisms the level of full employment will always be achieved. • In the economy there will be no shortage of demand. Interest Rate Determination • Classical economists believe that changes in interest rates will guarantee equality between the amount of savings that a household will provide and the amount of investment. • Interest rates determine the amount of savings or investment to be made in the economy. Determination of the level of Economic Activity • The level of economic activity of the country will be determined by: a. The amount of capital goods available and used in the economy. (K) b. The number and quality of labor available in the economy. (L) c. The amount and type of natural wealth used. (R) d. The level of technology used. (T) • The level of economic activity or national income can be determined using the following equation: • Y ＝ f (K, L, R, T) Weaknesses of the Classical View • In Keynes theory it is shown that the level of economic activity does not always reach the level of full use of labor . • At a time when the world economy is experiencing a very serious setback, people have increasingly doubted the truth of the income of classical economists. • Lack of aggregate demand in the economy is a source of very poor unemployment and economic setbacks. Keynes’s Criticism of the Classical View • Keynes argues: full use of labor is a rare situation, and it is caused by a lack of aggregate demand in the economy. • The difference of opinion between Keynes and classical economists comes from two problems: a. Factors that determine the level of savings, the level of investment and interest rates in the economy. b. Traits between the level of wages and the use of labor by employers. Determinants of Savings and Investment: Keynes’s View • Determinants of savings • According to Keynes, the amount of savings made by households is not dependent on the high or low interest rates. But it depends on the size of the level of household income. • Determinants of investment • According to Keynes interest rates continue to recognize that interest rates play a role in the consideration of entrepreneurs investing. • Other factors such as the current state of the economy, forecast of future developments and the extent of the prevailing technological developments. Differences in Views Regarding Savings Determinants • Classical views • According to classical economists the amount of savings is determined by interest rates. • Keynesian view • Low national income, low community savings and vice versa. Interest Determinants: Keynes’ View • According to keynes interest rates are determined by the demand and supply of money. • The central bank will provide money in accordance with what the community needs and the amount does not depend on interest rates. • Conversely, interest rates greatly affect the demand for money. Wage Levels • In the classical analysis that wage rates can change. • In the form of a modern economy it can be seen that the level of wages is not easy to decline. Determination of Economic Activities: Keynes’ View • The role of aggregate demand in economic activity • Keynes analysis pays more attention to aspects of demand, namely analyzing the role of demand for various groups of people in determining the level of economic activity to be achieved by an economy. • Keynes analysis argues that the level of economic activity of a country is determined by the amount of demand. Determinants of Aggregate Demand • In Keynes analysis divides aggregate demand by two types of expenditure: • Consumption expenditure by households • Investment by entrepreneurs • In macroeconomic analysis of aggregate expenditure This includes expenditure: • Government expenditure • Exports • Household consumption • Comparison between consumption expenditure at a certain income level is called consumption bias. • Investment (investment) • Marginal efficiency of capital and interest rates • Describe the rate of return on capital to be obtained from investment activities carried out in the economy. • If interest rates are high from the marginal efficiency of the investment, then the entrepreneur will cancel his plan to invest. • Government spending • The government not only functions to regulate economic activity but also can influence the level of aggregate expenditure in the economy. • Exports • The rapid development of exports causes a rapid increase in aggregate spending which will ultimately lead to a rapid growth of national income. Current Approaches in Determining Economic Activities • Developing economies in developed countries • Main problems facing developed economies • Maintaining employment and avoiding inflation problems • Creating faster economic growth in the long run • Developing macroeconomic analysis • Monetary groups • Milton Friedman ( chicago university), criticizing Keynes’s views in the following: 1. Friedman believes the free market system is quite efficient in regulating economic activity and does not support excessive government interference in economic activity. 2. Friedman shows the role of money supply in determining the level of economic activity. Changes in money are very important in influencing economic activity and interest rates. 3. Regarding Friedman’s government policy, he prefers monetary policy. According to Friedman, the fiscal policy emphasized by the Keynesian group does not have too big an effect on influencing economic activity. • The new classical class (rational expectations) • The New Classical Economics theory, that all types of markets operate efficiently and can quickly make adjustments to the changes in force. • In the opinion of the theory of rational expectations the level of prices and the level of wages can easily change. • Economy in terms of bidding. • Ronald Reagan (US president 1980), disliked excessive government interference in the economy. • In the Keynesian group unemployment is overcome by fiscal policy and monetary policy, but it will cause faster inflation. • Supply side policies seek to realize • Workers will work harder and more efficiently • Business efficiency can be increased and production costs reduced • Develop the role of the private sector and encourage more competition • New Keynesian groups • Continue to believe that government policies are still needed to stabilize economic activities and strive for the economy to still achieve employment opportunities. • Price levels and national income balance • Keynesian balance analysis which shows the role of aggregate expenditure in determining national income has two weaknesses: • The analysis does not pay attention to the effect of changes in price levels on the balance of national income. • In determining equilibrium, a Keynesian analysis does not pay attention to aggregate supply. • In the analysis, the aggregate demand curve or AD curve and the aggregate supply curve or AS curve are used. • Characteristics of the AD curve • The AD curve explains the relationship between the level of prices in the economy and spending that will be done. • The value of expenditure is determined by two factors: • The value of aggregate expenditure, aggregate expenditure is very closely related to national income. The higher the national income the higher the aggregate expenditure. • Demand and supply of money.