Chapter 9 Flashcards
Okun’s “law.”:
an empirical inverse relationship between the unemployment rate and real GDP growth
“full-employment output” (Y*):
for modeling purposes, a level of output that is assumed to correspond to a case of no excessive or burdensome unemployment, but the likely existence of at least some transitory unemployment
aggregate demand (AD)
(in a simple model without government or foreign trade): what house-holds and firms intend to spend on consumption and investment: AD = C + I1
Aggregate Demand = Consumption + Intended Investment
AD = C + II
behavioral equation:
in contrast to an accounting identity, a behavioral equation reflects a theory about the behavior of one or more economic agents or sectors. The variables in the equation may or may not be observable
marginal propensity to consume:
the number of additional dollars of consumption for every additional dollar of income (typically a fraction between zero and one)
marginal propensity to save:
the number of additional dollars saved for each additional dollar of income (typically a fraction between zero and one)
The macroeconomic goal that involves keeping the rate of unemployment and inflation at acceptable levels over the business cycle is the goal of ___________ .
stabilization
The _________ economists believe that aggregate demand needs active guidance, whereas the ___________ economists believe that aggregate demand can take care of itself.
Keynesian, classical
The recurrent fluctuations in the level of national production is called the ___________ .
business cycle
When economic activity declines, usually measured by a fall of real GDP for two consecutive quarters, the economy is said to be in a ___________.
recession
The equation that expresses the inverse relationship between the unemployment rate and the rapid growth of real GDP is known as ___________ .
Okun’s “Law”
The level of output that occurs when the economy is not suffering from an unemployment problem (that is, when any unemployment that exists is just transitory), is called ___________ output.
full employment output
In the traditional macro model (with no government or foreign sector), what households and firms intend to spend on consumption and investment is called ___________
aggregate demand
The equation AD = C + II is a(n) __________, because it reflects a theory about the behavior of one or more economic agents or sectors. The equation Y = C + I is a(n) ___________, because it represents the actual level of aggregate spending that in fact occurs.
behavioral equation, accounting identity
In the Keynesian consumption function,
C = C + mpc Y, C represents _______, the mpc is the __________, and Y represents __________.
autonomous consumption, the marginal propensity to consume, aggregate income.
The ________ is the portion of every dollar of aggregate income that is saved, and can be expressed as ΔS/ΔY..
the marginal propensity to save
The formula 1/(1-mpc) is the formula for the “income/spending __________” in a simple closed economy with no government.
multiplier
T/F: The two “stylized facts” of the business cycle are always corroborated by the historical evidence.
False. The two stylized facts are not always true. There are periods when the
economy has gone into recession and the inflation rate has increased. And there
are periods when the economy has gone into an expansion, and the inflation rate
has not increased.
T/F: According to Okun’s Law, as originally formulated in the early 1960s, a 1% drop in the unemployment rate is associated with an approximately 3% increase in real GDP.
True.
T/F: Y = AD only when actual investment equals intended investment.
True.
T/F: In a situation with insufficient aggregate demand, C + II < C + I
True.
T/F: According to the classical economists, a sudden fall in investment spending would cause a fall in the interest rate, and the lower interest rate would then stimulate investment spending again and return it to its original level.
False. The lower interest rate would primarily dampen saving and stimulate
consumption spending, and the economy would return to equilibrium with a
higher composition of consumption spending and less investment spending than
before.
Explain the two “stylized facts” of the business cycle.
As GDP falls during a contraction, unemployment rises because producers are
producing less goods and services and need fewer workers. And during an expansion, producers need more workers as they increase production, so the unemployment rate
falls (stylized fact #1).
As producers increase their production, however, there’s more competition for the limited supply of workers and other inputs, which bids up wages and prices and results in an increase in the rate of inflation. Whereas during an economic contraction, there’s less pressure on wages and prices and the rate of
inflation slows down or becomes negative (stylized fact #2).
What was the response to the Great Depression of economists trained in the classical school?
Classical economists thought that the economy would recover by itself, so there was no need for the government to intervene.
- Explain the difference between the behavioral equation AD = C + II, and the
accounting identity Y = C + I (in a simplified economy with no government or foreign
sector).
The behavioral equation AD = C + II expresses the spending intentions by firms and households. They may not actually spend the amount that they intended to. The accounting identity Y = C + I expresses the actually spending that has occurred (which can be tallied up in the national accounts and is theoretically equal to GDP – at least in the simplified economy with no government or foreign sector).
- What are the determinants of investment spending in the Keynesian model, and
which factor is plays the most important role (especially in a recession)?
The determinants of investment spending are: the interest rate, prices of investment goods, accumulated assets and debt, the willingness of lenders to lend, but most
important for Keynes was the level of confidence and expectations about the future.
- In the Keynesian model, what happens to investment and inventories when there is insufficient aggregate demand?
When there’s insufficient aggregate demand, there will be unintended investment and excess inventory accumulation.
- Explain what is meant by “the multiplier,” and describe it in words.
When spending drops by a certain amount, output drops by more than that amount,
i.e. by a multiplied amount. This is because the drop in spending has a feedback or
echo effect on the economy. As firms cut back production and lay off workers, those
workers now have a drop in income, and cut back their own consumption. So this
affects additional firms, who see their inventories pile up and thus cut back
production. Thus more workers are laid off and incomes fall further, etc. etc.
What are the basic steps to deriving the multiplier algebraically?
To solve the multiplier algebraically, first substitute the consumption function into the equation for AD (AD = C+II). Then set Y=AD, and solve for Y.
Keeping the economy balanced with acceptable levels of unemployment and
inflation is the key aspect of the goal of:
stabilization
Two stylized facts of the business cycle are that:
during an economic contraction, unemployment rises and inflation falls,
while during an expansion, unemployment falls and inflation rises.
- What is the goal of stabilization policy?
To keep the econ. in the grey area, to avoid the threats of both excessive unemployment & inflation.
- What best describes the meaning of aggregate demand in the traditional macro model (with no government and a closed economy)?
The amount firms and households intend to spend on consumption and investment.
- According to the simplified macro model (with no government and no foreign sector), which of the following characterizes an economy in equilibrium?
a. When leakages = injections
b. When saving (S) = intended investment (II)
c. When Y = AD
d. When actual consumption and investment spending equals the intended consumption and investment spending.
In the classical model:
a. flexible markets will keep the economy at a full-employment level of spending and output.
b. both households’ saving activity and firms’ investment activity are quite sensitive to changes in the interest rate.
c. adjustments in the interest rates quickly correct any imbalances between saving and investment.
d. a sudden fall in investment spending would cause a fall in the interest rate, which would dampen saving and stimulate consumption, quickly returning the economy to full employment.
What can describe the meaning of autonomous consumption?
a. The part of consumption that is not related to income.
b. That which, when it changes, shifts the consumption schedule up or down.
c. A minimum level of income that people feel required to spend for survival.
d. The amount of consumption spending people will undertake no matter what their current incomes are, reflecting their long-term plans, their commitments and habits, and their place in the community.
The marginal propensity to consume (mpc):
a. stands for the portion of every additional dollar of aggregate income that goes to consumption spending.
b. is equal to the change in consumption (C) divided by the change in aggregate income (Y).
c. is equal to 1 – mps.
d. theoretically should be less than 1
What factors will not cause a shift in the consumption function (or schedule)?
A change in income
In the Keynesian model:….
Investment spending is highly sensitive to investors’ confidence and
expectations of future sales and profits (or “animal spirits”).
What will not cause a shift in the investment function (or schedule) in the Keynesian model?
A change in household disposable income
If aggregate demand falls below aggregate output (AD
There is an accumulation of unintended inventories.
Unlike the Classical economists, Keynes thought that after a sudden fall in investment spending:
the economy could contract by even more than the initial fall in spending, and get stuck there.
What expresses the value of the income/spending multiplier (in a simple closed economy with no government)?
1/(1-mpc)
Assume a simple, closed economy with no government. The marginal propensity to consume (mpc) = 0.75. Then the value of the multiplier is:
4
What best describes the relationship between the mpc and the multiplier?
The higher the mpc, the higher the multiplier.
Assume a simple, closed economy with no govt. The marginal propensity to consume (mpc) = 0.8. Assume there’s a sudden drop in investment spending by 100 million. By how much will output eventually fall?
500 Million
