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Chapter 7- Economic Growth
Explain the different objectives of (long-run) growth policy versus (short-run) stabilization policy.
Explain the different objectives of (long-run) growth policy versus (short-run) stabilization policy.
answer
Long-run growth policies encourage capital formation, education and training, and the development of new technology. The objective of growth policies is to shift the production function upward and ensure that the economy sustains a high long-run growth rate. The objective of (short-run) stabilization policy is to maintain the actual GDP close to potential GDP in the short run, so that neither high unemployment nor high inflation is a problem.
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Chapter 7- Economic Growth
Explain why economic growth might be higher in a country with well-established property rights and a stable political system compared with a country where property rights are uncertain and the government is unstable.
Explain why economic growth might be higher in a country with well-established property rights and a stable political system compared with a country where property rights are uncertain and the government is unstable.
answer
A stable political system and well-established property rights provide the foundation for firms to make long-term capital investments. Firms will not make long-term investments such as factories, if there is a risk that the government will collapse or decide to nationalize the industry and confiscate the factory.
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Chapter 7- Economic Growth
What causes shift in the production function?
What causes shift in the production function?
answer
More capital, improved workforce quality (normally measured by the amount of education and training), and better technology all raise labor productivity and therefore shift the production function upward.
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Chapter 7- Economic Growth
What does growth rate of labor productivity depend on?
What does growth rate of labor productivity depend on?
answer
Growth rate of labor productivity- the rate at which the economy builds up its capital and rate at which technology and workforce quality improves
It depends on:
1. rate of capital formation-encouraged by interest rates, favorable tax, technology, growth of demand, and political stability
2. rate of improvement of workforce quality- encouraged by education and training
3. rate of technical progress- encouraged by education and higher rates of investment
It depends on:
1. rate of capital formation-encouraged by interest rates, favorable tax, technology, growth of demand, and political stability
2. rate of improvement of workforce quality- encouraged by education and training
3. rate of technical progress- encouraged by education and higher rates of investment
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Chapter 8- Aggregate Demand
What is a consumption function and why is it a useful device for government economists planning a tax cut?
What is a consumption function and why is it a useful device for government economists planning a tax cut?
answer
A consumption function shows the aggregate consumer expenditures to be expected at different levels of disposable income. Since a tax reduction results in an increase in disposable income, economists can use the consumption function to predict the initial change in spending that will follow a tax cut.
question
Chapter 8- Aggregate Demand
Explain why permanent tax cuts are likely to lead to bigger increases in consumer spending than temporary tax cuts do.
Explain why permanent tax cuts are likely to lead to bigger increases in consumer spending than temporary tax cuts do.
answer
People tend to base their consumption expenditures not just on their current income, but also on the level of income that they expect in the future. A temporary tax cut raises today's disposable income but not expected future income, so consumers are not likely to change their expenditures as much as they would if they expected a permanent increase in disposable income.
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Chapter 8- Aggregate Demand
What is aggregate demand?
What is aggregate demand?
answer
Aggregate demand is the total volume of goods and services purchased by households, firms, government, and international components (exports and imports)
Aggregate Demand = GDP = National Income in equilibrium
Aggregate Demand = GDP = National Income in equilibrium
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Chapter 8- Aggregate Demand
What are the components of GDP?
What are the components of GDP?
answer
1. Consumption (private sector; domestic)
- non-durable: ex- coffee
- durable: ex- laptop
- service
2. Investment (private sector; domestic)
- new plant and equipment (capital)
- inventory change
- new residential structures
3. Government spending (domestic)
- federal, state, or local (school districts)
4. Exports (international)
- produced domestically, consumed abroad
5. Imports (international)
- produced abroad, consumed in domestically
- non-durable: ex- coffee
- durable: ex- laptop
- service
2. Investment (private sector; domestic)
- new plant and equipment (capital)
- inventory change
- new residential structures
3. Government spending (domestic)
- federal, state, or local (school districts)
4. Exports (international)
- produced domestically, consumed abroad
5. Imports (international)
- produced abroad, consumed in domestically
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Chapter 8- Aggregate Demand
What is national income?
What is national income?
answer
National income is the sum of incomes that all individuals in the economy earn in the form of wages, interest, rents, and profits; excludes government transfer payments; calculated before deductions for income taxes.
factor payments + profits - income taxes - transfer payments
The derived value is the income of domestic firms earned abroad or income earned of foreign firms in domestic economy.
factor payments + profits - income taxes - transfer payments
The derived value is the income of domestic firms earned abroad or income earned of foreign firms in domestic economy.
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Chapter 8- Aggregate Demand
What is disposable income?
What is disposable income?
answer
Disposable income is the sum of incomes of all individuals in the economy after taxes and transfers.
DI = Personal Income(income you earn after taxes) - Taxes
DI = Consume + Save
DI = Personal Income(income you earn after taxes) - Taxes
DI = Consume + Save
question
Chapter 8- Aggregate Demand
What causes shift and movement of the consumption function?
What causes shift and movement of the consumption function?
answer
Movement along consumption function
1. change in disposable income
Shift of consumption function
1. change in price level (ex- inflation)
2. change in temporary or permanent taxes or income
3. change in interest rates (ex- buying a house)
4. change in expectations
5. change in exchange rates
1. change in disposable income
Shift of consumption function
1. change in price level (ex- inflation)
2. change in temporary or permanent taxes or income
3. change in interest rates (ex- buying a house)
4. change in expectations
5. change in exchange rates
question
Chapter 8- Aggregate Demand
Why is investment the most volatile component of aggregate demand?
Why is investment the most volatile component of aggregate demand?
answer
Investment is the most volatile component of aggregate demand because business investment is closely tied to confidence and expectations and because housing investment depends on the likely future behavior of house prices.
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Chapter 8- Aggregate Demand
What is autonomous consumption?
What is autonomous consumption?
answer
Autonomous consumption is the amount of consumption regardless of disposable income (ex- family consumes food, water, and shelter regardless amount of disposable income)
constant level of spending by household (like a price floor)
constant level of spending by household (like a price floor)
question
Chapter 9- Demand Side Equilibrium
What is recessionary gap and inflationary gap?
What is recessionary gap and inflationary gap?
answer
Recessionary gap is the amount by which the equilibrium level of real GDP falls short of potential GDP.
Inflationary gap is the amount by which equilibrium real GDP exceeds full employment level of GDP.
Inflationary gap is the amount by which equilibrium real GDP exceeds full employment level of GDP.
question
Chapter 9- Demand Side Equilibrium
What is the equilibrium level of GDP on the demand side?
What is the equilibrium level of GDP on the demand side?
answer
The equilibrium level of GDP on the demand side is the level at which total spending just equals production. Because total spending is the sum of consumption, investment, government spending, and net exports, the condition for equilibrium is
Y = C + I + G + (X-M).
Output levels below equilibrium are bound to rise because when spending exceeds output, firms will see their inventory stocks being depleted and will react by stepping up production.
Y = C + I + G + (X-M).
Output levels below equilibrium are bound to rise because when spending exceeds output, firms will see their inventory stocks being depleted and will react by stepping up production.
question
Chapter 9- Demand Side Equilibrium
What causes movements and shifts of aggregate demand?
What causes movements and shifts of aggregate demand?
answer
Movement
1. change in disposable income
Shift
1. change in price level
2. change in interest rates
3. change in exchange rates between currencies
4. change in expectations
1. change in disposable income
Shift
1. change in price level
2. change in interest rates
3. change in exchange rates between currencies
4. change in expectations
question
Chapter 9- Demand Side Equilibrium
How does the need for policy affect equilibrium?
How does the need for policy affect equilibrium?
answer
Wage, price, interest rates, and exchange rates flexibility leads to equilibrium.
Strict wage, price, interest rates, and exchange rates make equilibrium less likely impossible.
Strict wage, price, interest rates, and exchange rates make equilibrium less likely impossible.
question
Chapter 9- Demand Side Equilibrium
What is the marginal potential to consume and save?
What is the marginal potential to consume and save?
answer
Marginal potential to consume:
change in DI = change in C + change in S = 1
Marginal potential to save:
change in C + change in S
------------- ------------- = 1
change in DI change in DI
0.8 + 0.2 = 1
change in DI = change in C + change in S = 1
Marginal potential to save:
change in C + change in S
------------- ------------- = 1
change in DI change in DI
0.8 + 0.2 = 1
question
Chapter 9- Demand Side Equilibrium
What is the multiplier effect?
What is the multiplier effect?
answer
Multiplier = 1 1
-------- or --------
1 - MPC 1 - MPS
5 or 5
For every unit of consumption, 5 units of real GDP
Any autonomous increase in expenditure has a multiplier effect on GDP; that is, it increases GDP by more than the original increase in spending.
The multiplier effect occurs because one person's additional expenditure constitutes a new source of income for another person, and this additional income leads to still more spending, and so on.
-------- or --------
1 - MPC 1 - MPS
5 or 5
For every unit of consumption, 5 units of real GDP
Any autonomous increase in expenditure has a multiplier effect on GDP; that is, it increases GDP by more than the original increase in spending.
The multiplier effect occurs because one person's additional expenditure constitutes a new source of income for another person, and this additional income leads to still more spending, and so on.
question
Chapter 10- Supply Side Equilibrium
Explain why a decrease in the price of foreign oil shifts the aggregate demand supply curve outward to the right. What are the consequences of such a shift?
Explain why a decrease in the price of foreign oil shifts the aggregate demand supply curve outward to the right. What are the consequences of such a shift?
answer
A decrease in the price of foreign oil reduces the costs of production and thus raises the profits of firms, inducing them to produce more output. This is represented by a rightward shift of the aggregate supply curve, with a consequent increase in output and reduction in the price level.
question
Chapter 10- Supply Side Equilibrium
Comment on the following statement: "Inflationary and recessionary gaps are nothing to worry about because the economy has a built-in mechanism that cures either type of gap automatically"
Comment on the following statement: "Inflationary and recessionary gaps are nothing to worry about because the economy has a built-in mechanism that cures either type of gap automatically"
answer
The statement is overly optimistic; gaps are worrisome. An inflationary gap will eventually be eliminated, but only at a cost of the social disruption caused by inflation. A recessionary gap may not be cured at all, because the cure requires both prices and money wages to fall, and such falls are usually strenuously resisted. Even if prices and wages do fall, and the recessionary gap is eventually eliminated, the process is likely to take a long period, during which time the country will suffer from unemployment and lost output.
question
Chapter 10- Supply Side Equilibrium
Explain why rising prices reduce the multiplier effect of an autonomous increase in aggregate demand.
Explain why rising prices reduce the multiplier effect of an autonomous increase in aggregate demand.
answer
Rising prices reduce the multiplier because the real value of wealth that is denominated in money terms declines, and this leads people to reduce their consumer expenditures. In addition, rising prices increases imports, hence reduce net exports.
question
Chapter 10- Supply Side Equilibrium
Describe the aggregate supply curve.
Describe the aggregate supply curve.
answer
Aggregate supply:
1. horizontal region- sticky wage, price, interest rates, and exchange rates
2. middle range- flexible wage, price, interest rates, and exchange rates
3. vertical region- extreme volatile range; very large change in price level for small change in real GDP
Problems can be self solved along positive slope.
Horizontal region- no incentive for economy to adjust since there needs to be a big change to produce an effect
1. horizontal region- sticky wage, price, interest rates, and exchange rates
2. middle range- flexible wage, price, interest rates, and exchange rates
3. vertical region- extreme volatile range; very large change in price level for small change in real GDP
Problems can be self solved along positive slope.
Horizontal region- no incentive for economy to adjust since there needs to be a big change to produce an effect
question
Chapter 10- Supply Side Equilibrium
What cause movements and shifts of the aggregate supply curve?
What cause movements and shifts of the aggregate supply curve?
answer
Movement
1. shift of aggregate demand... leads to change in price level and GDP
Shift
1. change in resource cost (wages)
2. change in technology
1. shift of aggregate demand... leads to change in price level and GDP
Shift
1. change in resource cost (wages)
2. change in technology
question
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answer
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