January 16, 2004
Intermediate Macro
The classical economists were quite proud of understanding supply and demand.
Their basic macro model focused on production. In the short-term capital is fixed so the level of output depends on the quantity of labor employed. Equilibrium in the labor market is achieved by changes in the real wage rate. Once output is determined by equilibrium in the labor market, the price level and the interest rate can be determined, but these two variables do not affect real output.
Keynes shifted attention to the demand for output. The Simple Keynesian Model shows how an autonomous decline in demand for investment goods can cause a fall in output with a multiplier effect.
A more sophisticated view of Keynesian ideas shows that the level of output is determined by circumstances in two financial markets: the long-term loanable funds market and the short-term market for money. From our perspective, this explains why this course is titled "Financial Markets and Economic Fluctuations." Economists do not all agree that Keynes' original analysis remains relevant, but a large majority think that financial markets are central to understanding business cycles.
To learn more about this topic, check out the Classic Economic Models.