Macroeconomics for Business Strategy

Question 1

Aggregate demand function and its components:

Answer 1

AD = C + I + G + NX

Question 2

Recalling Aggregate Demand

Answer 2

• ‘Shocks’ are amplified by multiplier
○ Government can stabilise economic
Fluctuations
§ Automatic stabilisers
§ Fiscal stimulus – offset decline in aggregate demand from the private sector
§ Austerity policies amplify -ve demand shocks
Rule: Fiscal stimulus in recession must be reversed in boom to prevent government debt from escalating (sovereign debt crisis)

Question 3

Multiplier

Answer 3

depends on:
• Rate of capacity utilisation (phase of business cycle): with fully employed resources, ↑G crowds out I
• Expectations of private sector: could be negative (multiplier) if rising fiscal deficit erodes consumer confidence
• Recession?
• Stage of Development?
• Type of economic activity? What do we mean by G?

Question 4

Crowding Out

Answer 4

• When ↑G (funded by tax or borrowing or both)
  
  • Leads to ↑r which then ‘crowds out’ private I and ↓NX
  • But, how extensive is this?
  • Again: What do we mean by G?

Question 5

What is the value of the Multiplier?

Answer 5

If close to 0, then justifies ‘expansionary austerity’ via ↓G, ↓r
• Leading to ↑I, C and NX
• Changes in expectations e.g. debt- to-GDP and stability of economy i.e. reduces default likelihood in future
• Reduces ‘risk premium’ for future and (therefore) long term r

Question 6

Neutrality of Money?

Answer 6

• Money Demand and Supply (LM)
• Nominal and Real
• Expectations
• Increases in Ms lead to increased prices
(as Ms > Md, so ↑C , ↑Ld, ↑W but as ↑P, so W/P stays the same)
• Neutrality of Money (in long run) - given matching of expectations and ‘reality’

But, in short run?
• Misperceptions (expectations)
• Sticky prices and wages (transaction costs)