Week 1: An overview om modern MacroEconomics

Question 1

How is microeconomics distinguished from macroeconomics?

Answer 1

Macro: how the overal national economy performs.
Micro: Deals with the behaviour of individual markets and the businesses, consumers, investors and workers that make up the economy.

Question 2

How is inflation defined, and how is it typically measured?

Answer 2

An upward movement of prices from one year to the next. Measured by the percentage change in price indices like consumer price index, producer price index or GDP deflator (Nominal GDP/Real GDP).

Question 3

How is the unemployment rate measured?

Answer 3

Number of unemployed persons divided by the number of people in the labor force.

Question 4

Describe the three kinds of unemployment.

Answer 4

Frictional: Natural, e.g. when people are in between jobs.
Cyclical: When economy dips into a recession.
Structural: When a change in technology makes a job obsolete.

Question 5

How is the rate of economic growth typically measured? Describe the two ways of measuring the gross domestic product.

Answer 5

Measured by growth in GDP. GDP = market value of all the goods & services produced in a country in a given year.
Flow of cost (income) approach: Wages + rents + interests + profits.
Flow of product (expenditures) approach: Consumption + Investment + Government expenditures + net eXports.

Question 6

What is the difference between actual and potential Gross Domestic Product?

Answer 6

Actual: what we produce.
Potential: What we could max produce withouth causing inflation.
act < pot => recesionary range
act > pot => inflationary range

Question 7

What is the difference between nominal GDP and real GDP?

Answer 7

Real GDP is adjusted for inflation

Question 8

Describe the phases of the business cycle.

Answer 8

recession => trough => recovery => Peak => ….

Question 9

What is fiscal policy?

Answer 9

investment or tax cuts to stimulate economy. Less investment & more taxes to contract economy and fight inflation.

Question 10

What is monetary policy?

Answer 10

Increase money supply to fight recession. Decrease money supply to fight inflation.

Question 11

Illustrate equilibrium in the aggregate supply-aggregate demand model.

Answer 11

(aggregate means total) AS slopes upward => the higher the price level, the more businesses will produce. AD slopes downward => as general price level falls, consumers and businesses will increase their demand for goods & services. Equilibrium where these two meet.

Question 12

What is the Classical view of unemployment?

Answer 12

Natural part of the business cycle. Self correcting and no need for the government to intervene.

Question 13

John Maynard Keynes flatly rejected the Classical notion of a self-correcting economy. Why?

Answer 13

Under certain circumstances the economy will not bounce back, but stagnate or fall into a death spiral. E.g. the great depression. => waiting for the long run is useless, because in the long run we’re all dead :-)

Question 14

What is demand-pull inflation.

Answer 14

Too much money chasing too little goods.

Question 15

What is cost-push inflation.

Answer 15

Rapid increases in prices of raw materials or wages drive up production costs.

Question 16

What was the Keynesian dilemma that arose because of stagflation?

Answer 16

They believe you either have high inflation or high unemployement. However stagflation came to be: High inflation + high unemployement. The dilemma was that their tools could only cure one of the two. e.g. cure inflation but give rise to more unemployement or vice versa.

Question 17

Milton Friedman’s Monetarist School argued that the problems of both inflation and recession may be traced to one thing. What is it?

Answer 17

Rate of growth of the money supply. Inflation happens when government prints too much money. Recession happens when government prints too little money.
Stagflation is the natural result of fiscal policy trying too push the economy beyond it’s natural rate of unemployement (aka lowest sustainable unemployement rate that can be attained without putting upward pressure on the inflation rate).

Question 18

In the 1980 presidential election, Ronald Reagan ran on a Supply-side platform that promised to do what?

Answer 18

Simultaneously cut taxes, increase government expenditures, accelerate the rate of economic growth WITHOUTH inducing inflation. Supply siders believed that people would work harder if they were allowed to keep more of the fruits of there labour. This would allow the nation to produce more aka supply side economics.

Question 19

New Classical economics is based on what controversial theory? What is the central policy implication of this, theory?

Answer 19

“rational expectations”: If you form your expectations rationally, you will take into account the future effects of active fiscal and monetary policies (thus rendering keynesian tactics useless). You can fool people for a while, but they will learn.

Question 20

What are the 4 big macroeconomic issues?

Answer 20

Inflation. Unemployement Rate. The rate of economic growth. Forecasting movements in the Business cycle.

Question 21

What are the major macroeconomic policy tools

Answer 21

Fiscal Policy & Monitary Policy tools

Question 22

How do monetarists cure stagflation?

Answer 22

By pushing the economy under it’s natural rate of unemployement. => inducing a recession. (not very popular :-))

Question 23

Why did supply side economics fail?

Answer 23

They thought that the budget deficit would reduce: The cut in taxes would be more then compensated by the increase in taxes caused by the rise in production (supply). However this didn’t happen.

Question 24

Give a brief history of the macroeconomic philosophies

Answer 24

Classic => Keynesian => Monetarism => Supply Side => New Classical => Keynesian => Biggest Fiscal stimules (e.g. quantitative easing) => …. No easy solutions because of deep seeded structural issues.