Chapter 11 Modern Macroeconomic Theories

Question 1

Any macroeconomic theory needs to explain what 3 things

Answer 1

Why recession unemployment occur
Why inflation occurs
How economics grow overtime

Question 2

Why did the classical theory fail.

Answer 2

Because it could not explain the great depression

Question 3

Why did the Keynesian theory fail

Answer 3

Because it showed its flaws when it was unable to fix the supply recessions of the 1970s

Question 4

The Phillips curve

Answer 4

The Phillips curve was a Keynesian idea.
It shows that there is a trade-off between inflation and unemployment.
IF SRAS is stable, any policy that eliminates unemployment will create inflation and vice versa.
The only way to lower both inflation and unemployment at the same time is to increase SRAS.

Question 5

Why did Keynesian economics merge with Monetarism.

Answer 5

To become a version of classical economics in which wages and prices did not change.
They largely abandoned Keynes views of expectations, investment, and the multiplier, perhaps because they were too “messy “to put into mathematical terms.

Question 6

Supply side economics

Answer 6

Supply side economics came in during the late 1970s and early 1980s as the economy went through supply recession.
It argues that incentives to workers through lower taxes and deregulation of the economy are necessary to create a stable economy.

Question 7

The Laffer curve

Answer 7

The Laffer curve suggests that cutting tax rates would increase the tax revenue collected by the government.
This was part of the Reagan economic package of the early 1980’s.

Question 8

New classical economists believe that recessions are caused by

Answer 8

Supply shocks, short term unpredictable changes to aggregate supply.
Among these are changes in the labor market caused by changes in the mix of industries within a country and the introduction of new technology that disrupts old industries and employment practices.

Question 9

New classicals believe in

Answer 9

Rational expectations, which along with the efficient market hypothesis, say that
markets always get the price right,
that people always see what is coming, and
that adjustments happen instantly, even sometimes before the actual event.

Question 10

New Keynesian economists tried to explain why wages and prices did not fall as predicted by the classical economists . What did they believe?

Answer 10

They believe that prices are sticky because it cost money to change them (menu costs) and
Consumers prefer stable prices ( information costs).
They believe that long term wage contracts and efficiency wage theory explains why wages are sticky downward.

Question 11

Efficiency wage theory

Answer 11

Says that high wages encourage workers productivity and allow companies to determine which workers to keep and which to fire in economic downtime’s.

Question 12

Natural rate of unemployment

Answer 12

•The natural rate of unemployment includes two components:–Frictional unemployment• workers being between jobs in the dynamic economy–
Structural unemployment• labor market failing to match up workers and firms in the market

Question 13

Neoclassical synthesis

Answer 13

keynesian macroeconomics + neoclassical microeconomics

• on the neoliberal/ free market side
• focused on equilibrium tendencies of macroeconomic system
• emphasized:
• -sticky prices
• -lack of information
• -dis-sequalibrium because of these

Question 14

Laffer Curve

Answer 14

-A curve which shows the relationship between tax rates and tax revenues of government and on which there is a tax rate at which tax revenues are a maximum

Question 15

Phillips Curve

Answer 15

-curve that shows the short-run trade-off between inflation and unemployment

Question 16

Deregulation

Answer 16

-The act of cutting the restrictions and regulations that government places on business.

Question 17

Supply shock

Answer 17

• an event that shifts the short-run aggregate supply curve.
• A negative supply shock raises production costs and reduces the quantity supplied at any aggregate price level, shifting the curve leftward. -A positive supply shock decreases production costs and increases the quantity supplied at any aggregate price level, shifting the curve rightward

Largely unpredictable events that negatively affect the economy in the short run.

Question 18

Rational expectation

Answer 18

-In economics, a theory stating that economic actors make decisions based on their expectations for the future, which are based on their observations and past experiences.

A basic example of rational expectations theory is a situation in which a consumer delays buyinga certain good because, based on his/her observations and experiences, he/she believes that the pricewill be less expensivein a month. If enough consumers believe that, demandeases and the good is likely to actually be less expensive next month. Thus, the consumer waits a month before buying the good. Rational expectations theory states that current expectations strongly influence future performance.
Economists disagree about how well the rational expectations theory works in the real world.

Question 19

Efficient market hypothesis

Answer 19

-says that not only do markets always set the right price for things, they set it virtually instantly.

Question 20

Inter temporal labor substitution

Answer 20

-recession that occurs due to the fact that the labor market cannot adjust quickly enough to larger changes in the economy.
Intertemporal labor substitution may also be caused by the increased use of capital, which replaces labor in some industries.

Question 21

Technology shock

Answer 21

-introduction of new technologies can cause recessions.

Question 22

Information costs

Answer 22

-information costs relate to the consumers
They are the costs associated with making the decision of what to buy.
Example for buying a car the information costs would include:costs for doing research, reading magazines, other publications, visiting car dealers, surfing the web, talking to friends etc

Question 23

Efficiency wages

Answer 23

-efficiency wages theory says that the businesses may choose not to lower wages to promote efficiency within the company during a recession.
The 2 reasons for this are
1 workers are not all the same.
2 incentives to workers- high paid workers have more incentives to work harder than lower paid workers.

Question 24

Menu costs

Answer 24

Are associated with changing prices.

For short periods at least, menu costs will help keep prices from changing.