Part 1. John Maynard Keynes is one of the most prominent economists of the 20th century. He established a new school of thought known as Keynesian economics. Keynes claimed that the government’s interventions are essential for the proper economy functionality. His basic idea was simple: governments should allow the budget deficit to maintain full employment during the economic slowdown, as the private sector investment is insufficient to keep production at normal levels and to get the economy out of recession. Keynesians appealed to governments to overcome problems by increasing government spending and/or tax cuts in times of economic crises (BBC, 2008). Keynes’ theory and book “The General Theory of Employment, Interest and Money” became very popular during The Great Depression and influenced the policy of many countries’ governments. For example, the "New Deal" of the U.S. president Franklin Roosevelt carried the state-monopoly regulation of the economy, and gradually normalized the situation in the country. The Great Depression was defeated within few years, and this was partially the reward of Keynesianism.
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However, Keynes had many opponents with their own points of view. Friedrich Hayek defended the classical liberalism and claimed that the government should eliminate all kinds of interventions. He believed that the latter are very harmful for the economy and negatively affect the market equilibrium. Milton Friedman also criticized Keynesianism. He argued that the government should regulate the economy only by changing the level of money supply.
Part 2. According to the expenditure approach of GDP calculation, GDP=C+I+G+(X-M) (Bureau of Economic Analysis, 2007). C=90,000; I=10,000; G=25,000; X=65,000; M=50,000; Net Export=15,000. Consequently, the GDP of Country A is equal to 90,000+10,000+25,000+ (65,000-50,000) =140,000 (cars). The price of a car is unknown, so the GPD can be calculated only in cars.
GDP Composition: C=64.29%; G=17.86%; I=7.14%; NX=10.71%.
GDP per capita= 140,000/500,000=0.28 (cars per capita).
The increase in the government purchases in the short run will increase the aggregate expenditure and cause the growth of the real GDP. It will shift the aggregate expenditures line (AE) upward and increase both the real GDP and interest rates. The equilibrium will move from E to F. However, an increase in the interest rates will cause private investment spending (I) go down. As a result, the aggregate expenditures will go down too. Consequently, this will move the equilibrium from F to L and decrease the real GDP.
The representatives of Keynesianism claimed that there is a significant dependence of the real GDP on the government’s policy. According to Keynes, the government can influence the real GPD by changing the level of government purchases and the interest rates. The government should maintain interest rates at the same level in order to avoid the decrease in aggregate expenditures. Such interventions are very important, especially during the economic slowdowns, to maintain full employment and normal level of production.
Part 3. The U.S. real GDP has been increasing for the last three years. This means that the economy is recovering, and there is a cycle of economic growth now. The real GDP in the third quarter of 2012 is 13638.1 billions of chained 2005 dollars, and the nominal GDP is 15797.4 billions of current dollars (Bureau of Economic Analysis, 2012). The nominal GPD is higher than the real GDP because it does not take into account the inflation rate.
Personal consumption is the largest component of GDP, and government expenditure is the smallest one. Consumer Price Index for All Urban Consumers is equal to 231.317 in October 2012 (Bureau of Labor Statistics, 2012). The CPI measures the inflation experienced by consumers, and shows how the consumer prices rise. The PPI measures the inflation at all stages of the production process, and is very important for companies. The GDP-Deflator measures the combined experience with inflation of governments, companies, and consumers.