Deck 19: Current Issues in Macro Theory and Policy

Question 1

Briefly describe the difference between a so-called real business cycle and a more traditional "spending" business cycle.

Answer 1

The real-business cycle theory says that fluctuations in the output of the economy are caused by significant changes in technology and resource availability. These changes will then affect productivity, theReal-business cycle theory then says that the fluctuations in the economy are not caused by changes in the spending of the economy.
Therefore, real-business cycle theorists do not agree with the government spending money during a recession to boost the economy, since the recession would have been caused by a bad shock to the production technology of the economy, which means it will not be efficient for firms to be producing at this point. If the government increases it's spending so that firms will produce more, then there will be a large amount of inefficiency.

Question 2

If the money supply fell by 10 percent, a monetarist would expect nominal GDP to________

A) Rise.
B) Fall.
C) Stay the same.

Answer 2

Monetarists say that at full-employment, aggregate demand increases and the price level will increase as well. Firms will increase their real output and the rate of unemployment will be reduced. In other words, an increase in the money supply would result in inflation, instability of real output, and employment.
Hence, the correct answer is b. Fall.
Option a. is incorrect because the GDP will rise if the money supply increaseD.Option c. is incorrect because the GDP will stay the same if the money supply remained unchangeD.

Question 3

Craig and Kris were walking directly toward each other in a congested store aisle. Craig moved to his left to avoid Kris, and at the same time Kris moved to his right to avoid Craig. They bumped into each other. What concept does this example illustrate? How does this idea relate to macroeconomic instability?

Answer 3

The situation is an example of a coordination failurE.A coordination failure when people fail to reach a mutually beneficial equilibrium because there is a lack of communication , which causes poor coordination.
In the example, both parties would have had a more beneficial outcome if they did not bump into each other. However, the poor coordination caused the two to not be able to get the "wanted" outcome of not bumping into each other, but the failure to communicate and coordinate caused them to be in a bad outcomE.In the economy, there could be instability when consumers and firms fail to coordinate properly. Suppose that firms and households think that other firms and households would cut back their investment spending. Thus, firms and household will anticipate a

Question 4

An economy is producing at full employment when AD unexpectedly shifts to the left. A new classical economist would assume that as the economy adjusted back to producing at full employment, the price level would_______

A) Increase.
B) Decrease.
C) Stay the same.

Question 5

State and explain the basic equation of monetarism. What is the major cause of macroeconomic instability, as viewed by monetarists?

Question 6

Use an AD-AS graph to demonstrate and explain the price-level and real-output outcome of an anticipated decline in aggregate demand, as viewed by RET economists. (Assume that the economy initially is operating at its full-employment level of output.) Then demonstrate and explain on the same graph the outcome as viewed by mainstream economists.

Question 7

Use the equation of exchange to explain the rationale for a monetary rule. Why will such a rule run into trouble if V unexpectedly falls because of, say, a drop in investment spending by businesses?

Question 8

Place "MON," "RET," or "MAIN" beside the statements that most closely reflect monetarist, rational expectations, or mainstream views, respectively:
a. Anticipated changes in aggregate demand affect only the price level; they have no effect on real output.
b. Downward wage inflexibility means that declines in aggregate demand can cause
c. Changes in the money supply M increase PQ; at first only Q rises because nominal wages are fixed, but once workers adapt their expectations to new realities, P rises and Q returns to its former level.
d. Fiscal and monetary policies smooth out the business cycle.
e. The Fed should increase the money supply at a fixed annual rate.

Question 9

According to mainstream economists, what is the usual cause of macroeconomic instability? What role does the spending-income multiplier play in creating instability? How might adverse aggregate supply factors cause instability, according to mainstream economists?

Question 10

Explain the difference between "active" discretionary fiscal policy advocated by mainstream economists and "passive" fiscal policy advocated by new classical economists. Explain: "The problem with a balanced-budget amendment is that it would, in a sense, require active fiscal policy-but in the wrong direction-as the economy slides into recession."

Question 11

Suppose that the money supply and the nominal GDP for a hypothetical economy are $96 billion and $336 billion, respectively. What is the velocity of money? How will households and businesses react if the central bank reduces the money supply by $20 billion? By how much will nominal GDP have to fall to restore equilibrium, according to the monetarist perspective?

Question 12

You have just been elected president of the United States, and the present chairperson of the Federal Reserve Board has resigned. You need to appoint a new person to this position, as well as a person to chair your Council of Economic Advisers. Using Table 36.1 and your knowledge of macroeconomics, identify the views on macro theory and policy you would want your appointees to hold. Remember, the economic health of the entire nation-and your chances for reelection-may depend on your selections.

Question 13

If prices are sticky and the number of dollars of gross investment unexpectedly increases, the______ curve will shift_______.

A) AD; right.
B) AD; left.
C) AS; right.
D) AS; left.

Question 14

Last Word: Compare and contrast the Taylor rule for monetary policy with the older, simpler monetary rule advocated by Milton Friedman.

Question 15

What is an efficiency wage? How might payment of an above-market wage reduce shirking by employees and reduce worker turnover? How might efficiency wages contribute to downward wage inflexibility, at least for a time, when aggregate demand declines?

Question 16

Assume the following information for a hypothetical economy in year 1: money supply = $400 billion;
a. What is the level of nominal GDP in year 1?
bSuppose the Fed adheres to a monetary rule through open-market operations. What amount of U.S. securities will it have to sell to, or buy from, banks or the public between years 1 and 2 to meet its monetary rule?

Question 17

First, imagine that both input and output prices are fixed in the economy. What does the aggregate supply curve

Question 18

How might relationships between so-called insiders and outsiders contribute to downward wage inflexibility?

Question 19

Suppose that the money supply is $1 trillion and money velocity is 4. Then the equation of exchange would predict nominal GDP to be:

A) $1 trillion.
B) $4 trillion.
C) $5 trillion.
D) $8 trillion.