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Learn the toughest concepts covered in your Macroeconomics class with step-by-step video tutorials and practice problems.

Macroeconomic Schools of Thought

New Classical Model


New Classical Model

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So throughout this course, we focus mainly on the Keynesian model of economics, let's go ahead and see another model, the new classical model of economics. So the new classical model of economics, well, guess what? It has similar views to the classical model of economics that was used prior to the Great Depression during the Great Depression. The Keynesian model was developed that focused on government intervention to help fight recessions and to help fight inflation as well. So the new classical model was developed by a few people robert Lucas, thomas, sergeant robert barrow in the 19 seventies, likely you don't have to know those names, but that's who developed it. Um And it has some um some big similarities to the classical model. That's why it's called the new classical model. So this model believes that the the economy tends to be at potential GDP, so we're at full employment and available resources are in use. So that's a big similarity between the Classical model and the new Classical model, that we tend to be at full employment potential GDP. They also believe that wages and prices are flexible, that they are able to adjust quickly to changes in supply and demand. This is one of the main difference from the keynesian models remember that the Keynesian model viewed prices as sticky. They're not able to change as quickly. Right? Um Especially when it comes to wages, a lot of times your wage isn't able to change or adjust that quickly, right? If if you're going through a recession, if the economy is going through a recession and then the your employer says, Hey, we're gonna cut your your pay by 10%, it's not so easy to lower your wage, right? Or if you're in a union and you have a contracted amount of wage, rather prices go up or down the price level changes inflation or a recession, well you're contracted wage is gonna stay the same. So that's one of the main views of the Keynesian model. While the new classical model believes that these are more flexible, that they are adjustable, uh they can adjust quickly. Okay, so that's, that's a big thing with the classical model. So one of the big additions that the new Classical model brings is the idea of rational expectations and this tends to deal mainly with inflation when we think about this rational expectations in this, in this model. So the idea is that firms and workers have expectations about the future value of economic variables. So they're gonna be decisions today based on what they think the future is gonna be like, such as what they think inflation is going to be like in the future. Okay, so one of the main things with the rational expectations theory is that if the actual actual inflation rate is different from the expected inflation rate, so they expect a certain level inflation, we think prices are gonna be 2% higher next year, but they end up being 10% higher next year. Well that's gonna have economic repercussions and we talk about that a lot more when we discuss the short run phillips curve and we discuss expected inflation, We discuss this this idea of rational expectations in that video a lot, but it leads to shifts in the short run phillips curve when these expectations are not met, okay, when these expectations about inflation are not met and that has effects on inflation as well as on unemployment as well. Okay, so to to try and fight this these differences between actual inflation and expected inflation, the new classical theory agrees that there should be some sort of monetary growth rule, so basically increases in the money supply. So another model we discuss is the Monetarist model and the Monetarist model focuses on that money supply. So this is an agreement that they have with this model. The new classical theory believes that there should be steady growth, a steady growth rule in the money supply. So when I say steady growth rule for the money supply, which will help firms and workers make expectations about inflation. Okay, so they're trying to make expectations about what inflation is going to be like. So if there's this steady constant rule that we're following regarding our money supply, well, we can make better guesses about what the future is going to be like and that's what the new classical model thinks about on the high level, you just kinda have to know about this but we focus mainly on that keynesian model in this class. That's the main focus of an introductory course like this. Alright, so that is our new classical model. Let's go ahead and pause and we'll move on to the next video.