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Unit 1: Introduction to Macro Economics

Thus, Fisher's quantity theory of money works as a supplement to Say's law of market. One is Notes
not complete without the other.

Walras' General Equilibrium Model

General economic equilibrium explained how all prices and quantities would exchange within
an entire economy for a given period. In contrast, partial equilibrium theory took, as given, all
prices and quantities exchanged except for one or two and attempted to explain those one or two
markets within the context of the other given prices and quantities.
To develop his general economic equilibrium theory, Walras first had to describe some of the
features of the social and economic setting of the market situation that was to be used in explaining
the prices and quantities exchanged. From his analysis, Walras came up with a law that proved
that if all markets but one are in equilibrium, then the last market must also be in equilibrium.
This meant that with any given set of prices, the total demand for all things exchanged must
equal the total supply of all things exchanged. Therefore, supply was a consequence of demand.
This implied that there would always be a demand for all newly produced commodities. If there
was disequilibrium or excess supply somewhere, then there must also be an equal disequilibrium
or excess demand somewhere else since total excess supply equaled total excess demand.

1.1.2 Keynesian Macro Economics

John Maynard Keynes is well known for his simple explanation for the cause of the Great
Depression. Keynes' economic theory was based on a circular flow of money. His ideas spawned
a slew of interventionist economic policies during the Great Depression. In Keynes' theory, one
person's spending goes towards another's earnings, and when that person spends her earnings
she is, in effect, supporting another's earnings. This circle continues on and helps support a
normal functioning economy. When the Great Depression hit, people's natural reaction was to
hoard their money. Under Keynes' theory this stopped the circular flow of money, keeping the
economy at a standstill.

Keynes's view that governments should play a major role in economic management marked a
break with the laissez-faire economics of Adam Smith, which held that economies function best
when markets are left free of state intervention.
Keynes argued that full employment could not always be reached by making wages sufficiently
low. Economies are made up of aggregate quantities of output resulting from aggregate streams
of expenditure - unemployment is caused if people don't spend enough money.

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Caution Keynes stated that if Investment exceeds Saving, there will be inflation. If Saving
exceeds Investment there will be recession. One implication of this is that, in the midst of
an economic depression, the correct course of action should be to encourage spending and
discourage saving. This runs contrary to the prevailing wisdom, which says that thrift is
required in hard times. In Keynes's words, "For the engine which drives Enterprise is not
Thrift, but Profit."

Tasks Find out more about JM Keynes-his achievements, contribution to the field of
economics, etc.

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