Chapter 12: Keynesian Perspective

Question 1

After what event did Keynesian Economic theory become more mainstream? Why?

Answer 1

Great Depression

Instead of letting the economy self-balance, active fiscal policy was used to alleviate weak aggregate demand

Question 2

How does Neoclassical economics prescribe dealing with a recession?

Answer 2

It will self-correct. No action needed. “Hands off” policy approach.

Question 3

How does Keynesian economics prescribe dealing with a recession?

Answer 3

Implement active fiscal and monetary policies

Question 4

What happens tot he aggregate demand curve in a recession?

Answer 4

Shifts left

Question 5

Person Keynesian economics is named after

Answer 5

John Maynard Keynes

Question 6

Economics theory that markets don’t self-correct quickly, because prices & wages take time to adjust. During recessions it is necessary for the government to get involved by using monetary and fiscal policy to increase output, decrease unemployment.

Answer 6

Keynesian Economics

Question 7

Stagflation

Answer 7

When inflation is high, economic growth rate slows, and unemployment remains steadily high

Question 8

Monetarism

Answer 8

Focused on price stability. Money supply should be increased slowly and predictably to allow for steady growth.

Question 9

Name that economics theory: Focuses on aggregate demand. Firms produce output only if they expect it to sell.

Answer 9

Keynesian Economics

Question 10

Potential Output

Answer 10

What can be produced if the economy is operating at maximum (natural) employment

Question 11

In Keynesian Economics, when AD (aggregate demand) falls, what occurs?

Answer 11

Less than full unemployment / recessionary gap. Government should increase spending to boost aggregate demand.

Question 12

In Keynesian Economics, when AD (aggregate demand) increases, what occurs?

Answer 12

Inflation, where demand attempts to push the economy past potential output. Government should decrease spending to ease aggregate demand.

Question 13

Aggregate Demand

Answer 13

Total spending, economy-wide, on domestic goods and services

Consumption + Investment + Government Spending + Net Exports

Question 14

Durable Goods

Answer 14

Things that last and provide value over time

Example: Automobiles

Question 15

Nondurable Goods

Answer 15

Once you consume them, they are gone

Example: Groceries

Question 16

3 Factors that affect consumption (Keynes)

Answer 16

1. Disposable Income
2. Expected Future Income
3. Wealth or Credit

Question 17

Disposable income

Answer 17

Take home pay / income after taxes

Question 18

How do consumer expectations for the future affect aggregate demand?

Answer 18

Optimistic - consume more

News of recession - pull back and spend less

Question 19

How do people spend beyond their income?

Answer 19

Borrowing/credit

Question 20

What will occur to Aggregate Demand (on a graph) if there is a shift towards consumption rather than saving?

Answer 20

AD will shift to the right

Question 21

4 Categories of Investment Expenditure

Answer 21

1. Durable equipment/software
2. Nonresidential structures
3. Change in inventory
4. Residential structures

Question 22

How does confident expectation of future profits affect business investment expenditure?

Answer 22

Businesses will increase investment

Question 23

How do low interest rates affect investment spending?

Answer 23

Increases investment/spending

Question 24

2 Factors that Affect Business Investment Spending

Answer 24

1. Expectation of future profits

2. Interest rates

Question 25

How can the government influence Aggregate Demand?

Answer 25

1. Increasing or decreasing government spending | 2. Lowering or raising tax rates

Question 26

Why do sticky wages and prices increase the impact of an economic downturn?

Answer 26

The macroeconomy adjusts slowly to shifts in aggregate demand because of wages and prices that do not respond to decreases/increases in demand

Question 27

2 Building Blocks of Keynesian Economics

Answer 27

1. Aggregate demand is not always high enough to incentivize firms to hire enough workers to reach full employment 2. Sticky wages/prices do not respond to demand shifts

Question 28

What kind of situation and timeframe does Keynesian Economics focus on?

Answer 28

Depressions/Recessions Relative Short Term Offers policy prescription for minimizing effects of economic downturn

Question 29

What "law" did the Great Depression contradict?

Answer 29

Say's Law that "supply creates its own demand". There were just as many factories and workers/same supply as before the crash, but not enough demand.

Question 30

Coordination Argument

Answer 30

No centralized way to implement coordinated wage reductions in bad economic times, so workers will fight against wage reductions. Keeps wages sticky.

Question 31

Menu Costs

Answer 31

Costs of changing prices. Price changes may leave consumers confused or angry.

Question 32

Expenditure Multiplier

Answer 32

Measure of how many times Real GDP will be increases/decreased as a result of an autonomous change in aggregate spending in the economy. (change in Y) / (change in spending) > 1 * Y = RGDP = aggregate demand spending

Question 33

How does an inflationary gap occur?

Answer 33

Aggregate demand increases when the economy is already at potential output. AS is already vertical, so any increase in AD leads to a higher price (inflation) but not higher GDP.

Question 34

Marginal Propensity to Consume (MPC)

Answer 34

Ratio of Change in Consumption Expenditure (C) to the Change in Disposable Income (DI) MPC = (change C) / (change DI)

Question 35

How to calculate the expenditure multiplier

Answer 35

Expenditure Multiplier = 1 / (1 - MPC) | * MPC = Marginal Propensity to Consume

Question 36

Phillips Curve

Answer 36

Inflation and unemployment have a stable and inverse relationship. With economic growth comes inflation, which it turn leads to more jobs and less unemployment.

Question 37

Keynesian Zone

Answer 37

Levels of output far below potential in the Aggregate Supply Curve. AS curve is flat. High unemployment, low inflation.

Question 38

Neoclassical Zone

Answer 38

Levels of output above potential in the Aggregate Supply Curve. As curve is essentially vertical. Low unemployment, high inflation.

Question 39

Intermediate Zone

Answer 39

Between the Keynesian and Neoclassical Zones in the Aggregate Supply Curve

Question 40

Stagflation

Answer 40

Unhealthy combination of high inflation and high unemployment. Could not be explained by traditional Keynesian economics.

Question 41

What do Keynesian macroeconomists view as the solution to a recession?

Answer 41

Expansionary fiscal policy such as tax cuts to increase consumption, or increased government spending. Shifts the demand curve to the right.

Question 42

Does Keynesian economics require government to set controls on prices, wages, or interest rates?

Answer 42

No. It focuses more on aggregate economic demand through government spending and tax cuts.

Question 43

3 Practical Problems with Keynesian solutions

Answer 43

1. government's ability to estimate GDP 2. government decision between tax cuts or spending 3. time lag for government legislation

Question 44

Multiplier Effect

Answer 44

An initial increase in spending cycles repeatedly throughout the economy, resulting in a larger impact than the initial dollar spent

Question 45

What occurs in an economy with a high multiplier?

Answer 45

Change in aggregate demand is magnified Economy is unstable Government policies on expenditure will have large effect

Question 46

What occurs in an economy with a low multiplier?

Answer 46

Change in aggregate demand is low Economy is relatively stable Government policy has weak effect on expenditures