In the new Keynesian Macroeconomics business cycles are driven by demand shock, while in the new classical...

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Economics

Inthe new Keynesian Macroeconomics business cycles are driven bydemand shock, while in the new classical macroeconomics they aredriven by supply shock. Explain the statement using your knowledgeof the AD AS model

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Solution The New classical economists buildtheir macroeconomic theories on the assumption that wages andprices are flexible They believe that prices clearmarketsbalance supply and demandby adjusting quickly NewKeynesian economists however believe that marketclearing modelscannot explain shortrun economic fluctuations andso they advocate models with sticky wages and pricesThe new classical model expalanation of businesscyclesThe new classical macroeconomics argues that business cycles occurin reaction to specific shocks including inter alia technologyshocks and fiscal shock basically within a traditional marketclearing frameworkHowever the new classical macroeconomics argues that the monetaryshock predicted has no real impact on the actual variables We alsoremember that wages and rates are perfectly flexible ensuring twoclassic outcomes that is to say instant full employment andlongterm money neutralityMany macroeconomists accept that monetary policy will affectunemployment and production at least in the short term the newclassical economy developed by Robert Lucas Thomas Sargent andRobert Barro emphasizes the role of flexible wages and prices butintroduces a new element called rational expectations to explainshortterm economic volatility or the emergence of marketcyclesNew classical macroeconomics holds that I wages and prices areflexible and ii people use all available information in order tomake decisions on the basis of which they shape their expectationsThe government cant fool the people under the theory as peopleare well educated and have access to the same information asgovernmentThe forecasts are objective according to rational expectations andare based on all available information That means people aremaking impartial forecasts The central premise in new classicalmacroeconomics is that the government can not manipulate peoplewith systemic economic policies because of reasonableexpectationsThe See Answer

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