The market systemAKA THE FREE MARKET AKA FREE ENTERPRISE AKA CAPITALISM

Adam Smith

“Father of Modern Economics”

Published The Wealth of Nations in 1776, which became the founding work of “Classical Economics”

Advocated “laissez faire” economics, with minimal government interference

Smith’s Prescriptions for a Recession

***If a recession occurs, the market will “self-correct”

The “invisible hand” of the market will cause the recession to (eventually) fix itself

This might require waiting for the “long run”, but the costs of government interference are not worth the government trying to actively fix the recession. In fact, government intervention might make a recession worse.

John Maynard Keynes

Published The General Theory of Employment, Interest, and Money in 1936 (during the Great Depression)

Challenged the tenets of Classical Economics; founded “Keynesian Economics” (the approach used by most modern governments, including the US), in which the government “fine-tunes” the economy in the short run.

Keynes’ Prescriptions for a Recession

***If a recession occurs, government intervention might be appropriate/necessary

The economy might fall into an “equilibrium” below full employment

Even if the recession might “self-correct” in the long run, it might not be worth waiting for the self-correction: “In the long run, we’re all dead” (Keynes)

For example, while a society waits for the economy to fix itself, many people might have to stay unemployed.

It might be worth the costs of government interference to address a recession in the “short run” with government policy.

Keynesians vs. Neo-Classical Economists

Today, there is an ongoing debate between Keynesian economists and “New Classical” economists that call for waiting for the long run and self-correction (for different reasons than the old Classicals).

Economic Profit vs. Normal Profit

Normal Profit is useful for taxing profits,

but Economic Profit tells an entrepreneur whether to enter, stay in, or leave an industry.

(We’ll need to illustrate on the board how this works.)

Some Final Economics Vocab

Creative destruction: a new technology/product destroys the market for an old technology/product (and markets for the inputs for that product)

Ex: Computers replaced typewriters, and at the same time destroyed demand for typewriter manufacturing laborers, typewriter repair, etc.

Derived demand: demand for a good/service creates “derived demand” for the inputs necessary to make that good or service

Ex: Increase in Demand for haircuts leads to an increase in Demand for scissors, barber labor.

Ex: Increase in Demand for baseball bats leads to an increase in Demand for wood, baseball-bat cutting machines (capital), etc.