Chapter 6: Macroeconomics The Big Picture

Question 1

What does microeconomics focus on?

Answer 1

how decisions are made by firms and individuals and the consequences of those decisions

Question 2

What does macroeconomics focus on?

Answer 2

how the actions of all individuals and firms in an economy interact to produce a particular economy-wide level of performance

Question 3

How does the traffic jam metaphor relate to one of the core parts of Macroeconomics?

Answer 3

The whole is greater than the sum of the parts – each driver slows down a bit more than the driver ahead, amplifying the response over time and from driver to driver. This is ultimately disproportionate to the initial driver who may have simply slowed down – this is the idea in macroeconomics that many thousands or millions of individual actions compound to produce an outcome that isn’t simply the sum of those individual actions.

Question 4

Explain the Paradox of Thrift

Answer 4

Families worried about money problems try to act responsibly by cutting spending. Businesses thus see less profit, and so they react by laying off workers. Families and businesses are thus worse off than if they hadn’t initially tried to cut spending

Question 5

What key insight into macroeconomics does the Paradox of Thrift offer?

Answer 5

The combined effect of individual actions can have results that are very different, and sometimes perverse, from what and individual initially intended. The behavior of the macroeconomy is greater than the sum of individual actions and market outcomes

Question 6

Before the 1930s and the Great Depression, what was the prevailing theory on government economic policy?

Answer 6

The economy was self-regulating and problems are resolved without government intervention through the working of the invisible hand

Question 7

What role did the Great Depression play in affecting macroeconomics

Answer 7

It helped to establish macroeconomics as an area of study. The destabilizing forces which led to the rise of Nazi Germany and fall of economies meant economists were needed to understand slumps and how to prevent them

Question 8

Keynesian Economics

Answer 8

Economic slumps are created by inadequate spending, and they can be mitigated by government intervention through fiscal or monetary policy

Question 9

Fiscal policy

Answer 9

uses changes in government spending and taxes to affect overall spending. These are typically actions by parliaments or congresses

Question 10

Monetary Policy

Answer 10

Uses changes in the quantity of money to alter interest rates and affect overall spending, These are typically actions by central banks.

Question 11

What is the most important effect of a recession?

Answer 11

Its effect on the ability of workers to find and hold jobs

Question 12

What is the most important indicator of labor market conditions?

Answer 12

The unemployment rate

Question 13

How do we officially decide when recessions begin and end?

Answer 13

The National Bureau of Economic Research officially declares when a recession started and ended usually on an ex-post facto basis. There is no exact definition for how recessions and expansions are defined

Question 14

How do recessions affect living standards?

Answer 14

living standards tend to decrease due to loss of jobs and difficulty in finding new ones

Question 15

Recessions are generally associated with three effects

Answer 15

1. a rise in the number of people below the poverty line
2. a rise in the number of people who lose their homes since they cannot pay mortgages
3. a rise in the number of people without health coverage (mainly US)

Question 16

What are the two main theories of macroeconomics which governments follow in regards to the business cycle?

Answer 16

1. Keynesian ideas of utilizing fiscal and monetary policy can be used to control recessions and stimulate growth after a downturn
2. Friedman’s consensus that both slumps and booms should be reigned in to smooth over the business cycle

Question 17

Long-Run Economic Growth

Answer 17

the sustained upward trend in an economy’s output over time

Question 18

Long-Run Economic Growth per Capita

Answer 18

the sustained upward trend in output per person

Question 19

What is Long-Run Economic Growth per Capita indicative of?

Answer 19

increased wages and living standards over time (this is largely why many developing nations focus on how to accelerate long-run growth)

Question 20

inflation

Answer 20

the overall increase in the level of prices

Question 21

deflation

Answer 21

the overall decrease in the level of prices

Question 22

Why can we not use supply and demand to understand inflation?

Answer 22

Supply and demand can only be used to explain how certain goods change in price relative to one another in a given timeframe. It cannot explain why a certain good, which might be cheaper now compared to other times, is more expensive than it was before

Question 23

How is inflation related to the business cycle?

Answer 23

When the economy slumps and jobs are harder to find, inflation falls. When the economy booms, inflation increases. Note that this is a short-run occurrence.

Question 24

How does inflation relate to a Central Bank’s desire to control an economic boom (Friedman’s theory)?

Answer 24

An economic boom can cause inflation rates to rise, and higher inflation rates typically mean more volatility, leaving the economy susceptible to worse outcomes. Raising interest rates (monetary policy) or enacting legislation (fiscal policy) can help to reign in uncontrolled inflation

Question 25

How is the overall level of prices determined in the long-run

Answer 25

In the short run, it’s determined by the business cycle and in the long run, it’s determined by changes in the money supply, or the total quantity of assets that can be readily used to make purchases

Question 26

Money supply

Answer 26

the total quantity of assets that can be readily used to make purchases

Question 27

How does inflation affect people’s affinity to cash?

Answer 27

It encourages people to get rid of cash and make purchases, but this can lead to runaway inflation, cause money to lose value, and leads to volatility

Question 28

How does deflation pose problems for the economy in relation to cash?

Answer 28

People decrease spending, as the value of cash increases relative to products, meaning less profit, lower employment, and worsening recessions

Question 29

Price Stability

Answer 29

the overall level of prices changes slowly or not at all. It is a desirable goal for economists

Question 30

Open Economy

Answer 30

An economy that trades goods and services with other countries

Question 31

Trade Deficit

Answer 31

The value of goods and services sold to foreigners is less than the value of goods and services bought from them

Question 32

Trade Surplus

Answer 32

The value of goods and services sold to foreigners is more than the value of goods and services bought from them

Question 33

What is the relationship between the success of an economy and whether it runs a trade deficit or surplus?

Answer 33

There is no simple relationship. Comparative Advantage explains why international trade occurs, but not why some countries run deficits and others surpluses. The answer may be that states with higher investment spending in relation to savings tend to run deficits and vice versa

Question 34

Investment Spending

Answer 34

Spending on goods like machinery and factories that are used to produce goods and services fo customers. Nations that have a higher investment spending to savings ratio tend to run trade deficits

Question 35

What did Keynes suggest was at the heart of economic slumps?

Answer 35

Inadequate spending

Question 36

What is an economic depression

Answer 36

A particularly severe recession

Question 37

The Four Indicators the NBER uses to date recession

Answer 37

1. Industrial production
2. Total sales in manufacturing, wholesale and retail
3. Non-farm employment
4. Real after-tax household income

Question 38

3 Symptoms of business cycles

Answer 38

1. recessions and expansions are irregular in their length and severity
2. unemployment rises sharply during recessions
3. production of durable goods is more volatile than services and nondurable goods