Macroeconomic overview

Question 1

What characterises the long run?

Answer 1

Y is fixed and P adjusts

K is exogenous and P is endogenous

Long-run models in which prices adjust flexibly emphasize the supply side of the economy -> aggregate supply determines output

Question 2

What characterises the very long run?

Answer 2

A, K and L adjusts

K is endogenous

Question 3

What characterises the short run?

Answer 3

P is sticky and Y adjusts

P and K are exogenous

Short-run models in which prices are sticky emphasize the demand side of the economy aggregate demand determines output

Question 4

What is the key equation in the long run closed economy?

Answer 4

Key equation: Y=C+I+G

Output Y is determined by capital K, labor L, and technology: Y=F(K,L)

Demand is given by consumption, investment, and government spending

C = C(Y-T)

I = I(r)

G and T are exogenous

Endogenous variable: r

Question 5

What is aggregate demand and supply and what is the equilibrium in the long run closed economy?

Answer 5

AD: C(Y-T)+ I(r) + G (Y, T and G fixed)

AS: Y=F(K,L) (all fixed)

Equilibrium: Y = C(Y - T) + I(r) + G (same fixed as above)

The real interest rate adjusts to equate demand with supply

Question 6

What are exogenous shocks to the closed economy in the long run?

Answer 6

Shocks to the savings curve

Shocks to the investment curve

Question 7

What is the special role of r in the long run closed economy?

Answer 7

r adjusts to equilibriate the goods market and the loanable funds market simultaneously.

If L.F. market is in equilibrium, then

Y–C–G = I

Add (C +G ) to both sides to get

Y= C+ I+ G(goods market eq’m)

Question 8

What characterises the long run small open economy?

Answer 8

Key equation: Y=C+I+G+NX

Savings may now differ from investment: Y-C-G=S=I+NX

In a small open economy, the interest rate r is fixed/exogenous (determined on world markets) and pins down I(r)

Hence NX is endogenous

Neither S nor I depend on ε, so the net capital outflow curve is vertical.

ε adjusts to equate NX with net capital outflow, S−I.

–> adjustment always through international trade (transmitted through changes in the real exchange rate)

Question 9

What are shocks to the long run small open economy?

Answer 9

Fiscal policy at home

Fiscal policy abroad affecting the world interest rate

Shock to investment demand

Trade protection