Answer to Question #275539 in Microeconomics for Blessing

Question

Although not explicitly mentioned in Chapter 20, John Maynard Keynes is considered a foundational source in the understanding of macroeconomics. After performing research outside the textbook, please explain in three well-structured paragraphs the basic principles of the New Keynesian Economics and how it addresses perceived limitations to classical Keynesian theory.

Answer 1

Solution:

The precepts of New Keynesian economics were developed as a reaction to criticisms aimed at John Maynard Keynes's original theories by New Classical economists. New Classical economists assume that imbalances in supply and demand are cleared by adjustments in prices and wages. New Keynesians regard prices as sticky causing involuntary unemployment and monetary policy to have a big impact on the economy.

The basic principles of New Keynesian Economics are as follows:

·        Sticky nominal wages.

·        Sticky nominal prices.

·        Steaky real wages.

·        Coordination failures.

 

New Keynesian explanations of sticky prices often emphasize that not everyone in the economy sets prices at the same time. Instead, the adjustment of prices throughout the economy is staggered. Staggering complicates the setting of prices because firms care about their prices relative to those charged by other firms. Staggering can make the overall level of prices adjust slowly, even when individual prices change frequently.

New Keynesian economics suggests that recessions result from a failure of coordination. Coordination problems can arise in the setting of wages and prices because those who set them must anticipate the actions of other wage and price setters.