1. Introducing Macroeconomics

2. Economics, but on a different scale…
International economics
National economy
Micro to Macro
Markets
Firms
Consumers

3. "To dig holes in the ground,
paid for out of savings, will
increase, not only
employment, but the real
national dividend of useful
goods and services.”
John Maynard Keynes
“If you put the federal government in charge of
the Sahara Desert, in 5 years there'd be a
shortage of sand. “
Milton Friedman
Macro economics is dominated by two
schools of thought; free-market
economics and Keynesian economics.

4. Free-market economists believe the market
mechanism is the best way to allocate
resources.
At the extreme, people can by very passionate
about this ‘belief’ and ignore the evidence of
market failure.

5. Keynesian economists
believe in
government
intervention to
‘correct’ the
economy.
People are also passionate (for and against)
Keynes. To some he is the antidote to greedy
capitalism. To others he is the enemy of
freedom.

6. Where did the debate start?
Adam Smith (1723-1790) more or less
invented the subject of economics. He
developed the idea that the economy worked
best when each individual pursued their own
self interest. He also recognised the
importance of the ‘invisible hand’ of market
forces in allocating resources to where they
were most needed.
Adam Smith’s ideas became the accepted
economic orthodoxy for many years. Free-
market (or classical) economic s grew out of
Adam Smith’s work. The government, it was
believed, had little role to play in managing
the economy.

7. The Great Depression
The Great Depression of the 1930s changed everything. The extent of deprivation,
unemployment and poverty was unprecedented in the modern world. The
depression became worse rather than getting better, as classical economists
argued it would. Economic theory failed to explain what was going on, or how the
problems could be solved…
• http://www.youtube.com/watch?v=VpKmfjf5tUk

8. Keynes to the rescue
In the 1930s, Keynes spearheaded a revolution in economic thinking,
overturning the older ideas of neoclassical economics that held that
free markets would, in the short to medium term, automatically
provide full employment, as long as workers were flexible in their
wage demands. Keynes instead argued that aggregate demand
determined the overall level of economic activity, and that
inadequate aggregate demand could lead to prolonged periods of
high unemployment. He advocated the use of fiscal and monetary
measures to mitigate the adverse effects of economic recessions
and depressions. Following the outbreak of the Second World War,
Keynes's ideas concerning economic policy were adopted by leading
Western economies. During the 1950s and 1960s, the success of
Keynesian economics resulted in almost all capitalist governments
adopting its policy recommendations.
http://en.wikipedia.org/wiki/John_Maynard_Keynes
“When the facts change I change
my mind – what do you do, sir?”
Actual Keynes quote!

9. Review
1. What is the difference between micro and macro
economics
2. What is a ‘school of thought’?
3. Name and explain the two schools of thought
discussed.
4. Name three important ideas that Adam Smith came
up with.
5. What was the Great Depression and how did it
‘disprove’ the idea that markets are self-correcting?
6. What did Keynes believe was necessary to solve the
economic problems of the time?

10. The critical role of the labour market
Unemployment is the fault Utter nonsense. People are
of government and trade unemployed because there is a
unions. If the labour lack of overall demand in the
market was allowed to economy. And demand won’t
work freely then there rise until people are in work.
would be no The economy is stuck in a
unemployment. Wages depression and government
need to fall to make need to act to get people in jobs
workers affordable! and stimulate demand…
Who was correct… the free-
market economists or Keynes?
Start your micro-debate now!

11. The Theory
Classical or Real-wage Unemployment
If a situation occurs whereby the supply
of labour exceeds the demand for labour
by firms unemployment results. If the
market is functioning freely then wage
levels should fall to the market-clearing
wage rate (W1). This increases the
demand for labour (workers become
more affordable) and reduces supply
(some people withdraw their services
from the market). Unemployment is
solved!
Or Demand-deficient Unemployment?
However, if the market fails to adjust then
unemployment will persist. Wages may be prevented
from falling by trade unions and job contracts which D2
specify a wage rate. Wages are ‘sticky downwards’.
Demand for labour is derived from Aggregate Demand
for goods. Therefore Keynes advocated stimulating
demand through government spending, thereby
increasing demand for labour.

12. The Keynesian Era
In 1936, Keynes published ‘The General Theory of
Employment, Interest and Money’. His ideas gradually
became the orthodox view, firstly in the UK and
eventually even in the US.
In 1971, the US President Keynesian policies…
Richard Nixon said
‘We are all Keynesians now’. In a recession, Keynes advocated:
• Increase government spending and reduced
taxation to increase aggregate demand (fiscal
policy)
• The use of monetary policy (e.g. interest rates)
to reduce borrowing costs
In a Boom, Keynesians would do the opposite and
reduce demand pressures to control inflation.

13. 1970s
Crisis in Keynesian Economics
In the 1970s, a new economic crisis arose.
Stagflation, simultaneous high levels of
unemployment and inflation, took off,
driven by oil prices and militant trade
unions pushing up workers’ wages. A
free-market counter revolution was
inevitable. The monetarists, Friedman
and Thatcher were waiting in the wings…

14. Monetarism, Friedman and Thatcherism
The high inflation of the 1970s was said by some to be the
result of too much money in the economy. The solution,
according to these monetarists, was to control the money
supply. This meant governments trying to control spending
and the use of controls over the money supply (credit
controls and interest rates).
Milton Friedman, an American economist, was the most
famous monetarist. He advised President Reagan’s policy in
the 1980s. He was also a strongly pro-market economist
and developed ideas on supply-side policies. The belief
behind this approach was that markets should be
competitive and efficient – sound familiar?
Margaret Thatcher became British Prime Minister in 1979. She was
heavily influenced by Friedman, monetarism and free-market economics.
Thatcher quickly set about reducing the power of trade unions to prevent
wage inflation and introduced severe spending cuts. By the mid-80s,
monetarism was abandoned as it was proving ineffective, but Friedman’s
free-market ideas still dominated and this led to the economic boom of
the late 80s.

15. A decade of stability…
Key events
• Early 1990s recession
• Labour came to power in
1997
• Bank of England given
control over interest rates
with the job to limit
inflation
• Decade of growth and
stability
…before the crash!
In 2007 the financial markets crashed leading the UK in to the deepest and longest
period of economic decline since the 1930s. Many blamed the crash on
unregulated financial markets. Free-market ideology once again came under fire.
Keynesian policies once again came into use as the Labour government built up
huge debts to bail out the banks and prevent a complete economic collapse.

16. Review
1. According to free-market economists, what was causing
unemployment in the 1930s?
2. What did Keynes argue would solve unemployment?
3. What economic problem was experienced in the 1970s?
4. Why couldn’t Keynesian policies solve this problem?
5. What did monetarists say the cause of 1970s inflation
was?
6. Why did Margaret Thatcher set about reducing the power
of the trade unions?
7. When was the ‘decade of stability’?
8. Why did Keynesian policy come back in to use in 2007?

17. Summary
Adam Smith creates the subject of micro-
economics and the free-market orthodoxy
which dominates until the 20th century.
John Maynard Keynes creates macro-economics
in response to the 1930s depression. He
advocates government intervention to boost
aggregate demand.
Milton Friedman leads the free-market counter-revolution as
unemployment and inflation soar in the 1970s. He blames
excess money supply, trade unions and government failure. A
new era of pro-market economic management begins.
The financial crisis of 2007 sends the UK in to its deepest
recession since the 1930s. Keynes’ policy comes to the
rescue. But who is to blame for the crisis; government or
the market?