Perspectives Test 2 Flashcards
On Keynes’ D curve, how do you show a change in the level of consumption. What about
a change in the level of investment. [23 words]
A change in consumption is a movement along the D curve. A change in investment is an upward or downward shift in D.
In Keynes’ view, why is it difficult to achieve a higher and higher level of N? [66 words]
As you move to higher Ns, Z gets steeper and D gets flatter. The additional consumption spending forthcoming from the rise in N is getting smaller and smaller yet firms need increasingly large jumps in sales to justify hiring.
What determines consumption in Keynes’ model? [1 word]
Income
What determines investment in Keynes’ model? Does mec move to meet r, or vice versa? [66 words]
I=f(mec, r)
+ -
Where mec is the present value of the expected stream of profits over the life time of a project as a percentage of the purchase price. Investment settles at the level where mec=r because firms will undertake project s until they are equal. For example, if mec>r, then there is an investment boom that causes decreased mec due to the rising stock of capital saturating that market.
In Keynes’ model, what maintains the equality of investment and saving? [79 words]
Changes in income restore the equality of I and S. S=Y-C C=a+bY Y=(1/1-b)(a+I) Whenever I changes, Y will change to compensate and S will follow. For example: I=50 b=.8 a=10 Y=(1/1-.8)(10+50)=5*60=300 C=a+bY=10(.8)300=250 S=Y-c=300-250=50 All at equilibrium and full employment. Lower I to 40: Y=5(10+40)=250 C=10+.8(250)=210 S=250-210=40 S and I are equal again, but at the cost of the level of economic activity.
How are interest rates determined in the General Theory? [107 words]
Interest determines how you save, not how much. It is the price of parting with liquidity rather than the reward for abstaining from consumption. There are three reasons to want to hold cash.
(1) Transactions motive: the need for cash for current personal and business transactions (varies positively with income.)
(2) Precautionary motive: a desire for security as to the future cash equivalent of assets
(varies negatively with optimism)
(3) Speculative motive: holding cash because you think current interest rates are a bad deal (varies negatively with R.)
When compared to the supply of money, this determines the interest rate.
How is Keynes’ rejection of Classical interest rate theory important? Explain. [34 words]
The classical interest rate theory guaranteed that Say’s Law would come to fruition. Keynes had to replace it in order to explain the Great Depression.
In what sense to banks hold a critical position in the production process? [14 words]
If they are unwilling to finance firms’ purchases of working capital, the process stops.
By uncertainty, Keynes meant what about bankers and entrepreneurs? [24 words]
Bankers and entrepreneurs lacked an objective basis for their expectations because there is no way that they could have sufficient knowledge about relevant circumstances.
Why would anyone in their right mind put down money at a game where they had no idea of the odds and what, at any given moment, determines whether or not US corporations are opening new facilities or laying off workers? [20 words]
Animal Spirits! It it is this balance between uncertainty and our animal spirits that determine whether or not U.S. corporations are opening new facilities or laying off workers.
What is THE driver of economic activity and what is the unintended consequence of firms deciding they don’t want to do it any more (using the car factory as an example)? [32 words]
Physical Investment. When firms chose to stop investing, they lay off workers. But now that it’s possible to make more cars because they have a new factory, people can’t afford to buy them because firms laid off workers when they stopped investing!
Briefly tell why a firm cares about its stock price after the initial sale (two reasons). [22 words]
1) Banks look at stock prices when deciding whether to issue credit. Thus, low stock prices make it more difficult to obtain funding and good interest rates.
2) The lower the stock price, the more stockholders will want to replace the manager.
Draw the schematic that shows how the stock market should affect economic growth. Which link may be broken if agents do not do a great deal of research before buying shares? [14 words]
more efficiency => higher stock price => cheaper access to funds => faster growth
The first link is broken.
In the stock market, why won’t “smart” money necessarily drive out the others and what does this mean there simply is no mechanism to do? [62 words]
The majority money drives the prices and determines who wins and who loses. Smart money is punished if it is in the minority. Under these circumstances, there is simply no mechanism forcing those buying and selling stocks to focus their attention on what would be most important for the economy (the long-term profitability of the firm itself)
The domination of the stock market by psychological factors leads to what? What sports analogy is used to explain the negative impact of this? [79 words]
It leads to much shorter time horizons for the decision making of firms where short-term variations in market conditions dominate firm’s long-term plans. It’s like a football team that thinks in terms of plays rather than drives— A coach would be ineffective if he believed that his team had to score a touchdown on every single offensive play, rather than strategizing over the course of a drive.
Hyman Minsky theorized what about economic agents and what did he say everyone would inevitably do? [64 words]
Minsky theorized that all economic agents incur debt with an eye toward how much their current and expected income will allow them to repay. Individuals, implicitly or explicitly, have an idea of the level of debt they can safely carry. As expansion continues, people raise their level of “safe” debt and are inevitably carried away.
In terms of when recessions start, at some point, someone somewhere say what? How can this evolve into a full-blown crisis and what may make us more susceptible? [44 words]
At some point, someone somewhere says, “Whoah! Sales are way off of what we expected!” If the gap between expectations and reality is big enough, this can evolve into a full-blown crisis. The level of debt everyone is carrying makes us even more susceptible.
In the preface to the General Theory to whom does Keynes say it was written (that was hard to find, wasn’t it!?)? [3 words]
My fellow economists.
In Keynes’ Chapter One (and don’t try to say you didn’t have time to read it!) he explains why he calls his a “general” theory. What is his explanation and why does he think it’s important? [64 words]
Keynes wishes to contrast his ideas with those of classical theory, which he argues only applies to a special case only and not the general and the conditions of that special case are not those of the world we actually live in. He claims that this leads to misleading teaching and disastrous effects if applied to the facts of experience.
