ECON2202, Macroeconomics Midterm (real)

What are the three features of comovement that macroeconomists are interested in?

-If it is leading or lagging -If it is procyclical/counercyclical/acyclical -How variable it is relative to GDP

Explain why forecasting GDP over the long term is difficult.

Due to the timeseries not being smooth(like a logarithm) and having no regularity in amplitude or frequency

What is investment?

Fixed investment creates capital such as machines Inventory investment is investment into stored goods for sale

What is the economic significance of the slope of the production possibilities frontier?

It is the marginal rate of transformation, that is to say the rate at which one good can be converted into another good

Why is it useful to study a closed-economy model?

It makes it much simpler to understand how the economy works, and the basics of what you learn can be applied to an open economy

Why can macroeconomic models be useful? How do we determine whether or not they are useful?

The purpose of an economic model is to capture the essential features of the world needed for analyzing a particular economic problem. To be useful then, a model must be simple, and simplicity requires that we leave out some "realistic" features of actual economies.

In a graph of the natural logarithm of an economic timeseries, what does the slope of the graph represent?

The slope of the graph is a good approximation to the growth rate of real per capita GDP, so that changes in the slope represent changes in the growth rate of real per capita GDP.

Why does a distorting tax on labor income lead to an inefficient economic outcome? How are the incentive effects of income taxation important for the Laffer curve?

The tax ends up creating a gap/wedge between the MRs(Marginal Rate of Substitution) and the MPl(Marginal Product of Labor), which discourages work and leads to over-consuming of leisure and under-consuming of consumption goods. This discouraging of labor can lead to less labor-hours completed/purchased by firms, leading to a decrease in tax revenue, despite higher taxes.

What are the three approaches to measuring GDP?

The threeapproaches are the product approach, the expenditure approach, and the income approach.

What is the difference between the trend and the business cycle component of an economic time series?

The trend provides information on longer-term movements in the seasonally adjusted data series over several years. The cycle is a sequence of smoother fluctuations around the longer-term trend in part characterized by alternating periods of expansion and contraction.

What makes macroeconomics different from microeconomics? What do they have in common?

-Macroeconomics is distinct from microeconomics in that it deals with the overall effects on economies of the choices that all economic agents make, rather than on the choices of individual consumers or firms. -Macroeconomics mainly focuses on long-run growth and business cycles. -Microeconomists and macroeconomists now use much the same kinds of tools/methods for measurement-

Besides persistence, what are three important features of the deviations from trend in GDP?

-The timeseries is choppy/not smooth -The amplitude is unregular, peaks and troughs have differing levels of deviance from the trend -There is no regularity in the frequency of fluctuations in real GDP about trend. The length of time between peaks and troughs in real GDP varies considerably.

What are the two key threads in modern business cycle theory?

(Assumption, unlisted in book, contacted professor) Coordination failures and New Keynesian Economics

Why was productivity growth low from 2010-2015?

(Assumption, unlisted in book, contacted professor) High debt had accumulated from the financial crises

What are the four conditions that a competitive equilibrium must satisfy for this model?

- Consumers choose the optimal point of consumption and labor supply(Ns) depending on their budget constraint (taxes, real wage, dividend income) to make themselves best off - Firms choose the quantity of labor demanded point that maximizes their profits, with maximized output (Y = zF(K, Nd)), and maximized profits (pi = Y - wNd) - The market for labor will settle at Nd=Ns, where the labor supplied and labor demanded is equal - The government budget constraint must be satisfied, where G(government spending)=T(taxes)

What did Robert Lucas say about the comovements among economic variables?

"with respect to qualitative behavior of comovements among [economic time] series, business cycles are all alike."

What are the effects of an increase in government purchases?

- Consumers do not receive direct benefits from the purchases, however the governments purchase private goods in order to convert them into public goods, such as roads/infrastructure, health services, defense, etc. On the other hand, consumers taxes will rise to compensate for the purchases, and thus decrease leisure and consumption as their income falls due to taxes - This can, however, shift down PPF and cause crowding out for the private sector as government spending increases

What three properties do the preferences of the representative consumer have? Explain the importance of each.

- Consumers will always prefer more, meaning they will become more consumerist as they have the ability to - Consumers like diversity, meaning they will not want the same good as repetitively as they would with a bundle of goods they like - Both consumption goods and leisure goods/hours are normal goods, relative elasticity unaffected by income

Explain three problems in the measurement of real GDP.

- It can be biased upward due to relative price changes over time (CPI) - Quality of goods can change over time (ex. 2015 cars are more expensive but also more advanced than 1995 cars) - Advances in new goods, such as Cellphones not existing when NIPA was created, and serving more functions than it did 10 years ago

What two properties do indifference curves have? How are these properties associated with the properties of the consumer's preferences?

- It is convex and bows toward the origin as consumers prefer diversity - It slopes downward because more is preferred to less

What is the representative consumer's goal?

- It is to gain the maximum utility in a bundle of physical goods and leisure, within heir budget constraint

What are the effects on the production function of an increase in total factor productivity?

- Labor demand shifts to the right as there is more marginal product per labor, similarly with capital

What are the characteristics of a steady state in the Solow growth model?

- Per capita capital, output, consumption, and savings will all remain the same

Give three reasons that an equilibrium might not be Pareto optimal.

- Primarily, they would not be pareto optimal due to externalities such as (negative)pollution, or (positive) having a public space as part of your building that is "attractive"(like a park, special archietecture, etc.) -Taxes can cause distortions, such as proportional income taxes sometimes discouraging more hours worked - Firms may not be price-takers at the time, for example, monopolies controlling market power over restricting output, altering prices, etc.

What are the seven economic growth facts?

- Prior to the industrial revolution, the standard of living remained fairly constant both over time and in differing countries - Post indsutrial-revolution, the growth of GDP(per cap.) growth has continued in richer countries, like the US and UK(nearly a straight light when using a logrithmic analysis) - Invesmtnet and output per worker are positively correlated globally - Population growth rate and output per worker are negatively correlated globally - Income inequality between the western nations and the rest of the world increased rapidly between 1800-1950(divergence) - Level of output per capita in 1960 and average output per capita growthrate after 1960 have remained uncorrelated (would've caused convergence) - Wealthier countries tend to be similar to eachother in rates of growth, whereas poorer countries are not

Why might hours worked by the representative consumer decrease when the real wage increases?

- Since leisure and consumption goods are normal good(income effect), they may consume more. - Substitution effect dictates that they may wish to work more to earn more money

Give a noneconomic example of two variables that are positively correlated and an example of two variables that are negatively correlated.

- Study time and exam grades, time and global population - Temperature and altitude, classes skipped and academic performance

What are the two determinants of the optimal quantity of public goods?

- The GDP, as public goods are normal goods, and an increase of GDP shifts the PPF curve to the right, increasing demand for public goods - The efficiency with which the government can convert private goods into public goods, along with the substitution effect in doing so.

Explain the difference between the first and second welfare theorems. Why is each useful?

- The first theory states that under some conditions, the competitive equilibrium will also be pareto optimal - The second theory states that a Pareto Optimum may sometimes be a competitive equilibrium They are both useful as pareto optimums, while technically the most "efficient" tend to be a very narrow view of social optimization, which ignores externalities(It focuses solely on a few consumers rather than a large market of consumers)

In the Solow growth model, what are the steady state effects of an increase in the savings rate, of an increase in the population growth rate, and of an increase in total factor productivity?

- The savings rate, s, increasing results in the szf(k*) curve shifting upward, which indicates an (non-aggregate/pemanent) increase in output and consumption. - An increase in the population rate decreases output/real wage, as they are negatively correlated - During a steady state, an increase in total factor productivity brings up all (per-capita) variables

What happens to public goods provision and private consumption when GDP increases, and when the opportunity cost of public goods provision becomes larger?

- There is a positive income effect for both private and public goods when GDP increases, as they are both normal goods in our one-period model. - If opportunity costs of public goods becomes larger, the socially optimal amount of public spending will decrease, and households will wish to save more of their income

When the consumer chooses his or her optimal consumption bundle while respecting his or her budget constraint, what condition is satisfied?

- They have gained the maximum utility

Explain why the marginal product of labor curve is the firm's labor demand curve.

-They will hire as necessary, and as they need less labor(as it becomes less valuable to them), they will hire for lower wages or less hours as it is no longer worth as much to them per worker

What are two difficulties in the measurement of aggregate output using GDP?

-Underground and illegal activities cause innacuracies -Mismatches in how government production is valued, such as national defense and highways

What are the five elements that make up the basic structure of a macroeconomic model?

1. The consumers and firms that interact in the economy 2. The set of goods that consumers wish to consume 3. Consumers' preferences over goods 4. The technology available to firms for producing goods 5. The resources available

List six fundamental macroeconomic questions.

1. What causes sustained economic growth? 2. Could economic growth continue indefinitely, or is there some limit to growth? 3. Is there anything that governments can or should do to alter the rate of economic growth? 4. What causes business cycles? 5.Could the dramatic decreases and increases in economic growth that occurred during the Great Depression and World War Il be repeated? 6.Should governments act to smooth business cycles?

Why might the vacancy rate rise without a commensurate reduction in the unemployment rate?

A mismatch could result in this. This mismatch could result from differences between the skills that firms want and what would-be workers possess, or because job vacancies are not in the same geographical regions where the unemployed reside.

How is the representative consumer's behavior affected by an increase in real dividend income?

A pure income effect occurs, as disposable income grows with prices staying the same(both leisure and consumption goods are normal goods)

What is the effect of an increase in total factor productivity on steady state population and consumption per worker in the Malthusian model?

An increase in total factor productivity shifts the curve upward, creating an decrease in unit land per worker for the same amount of consumption per worker(consumption point retained). This leads to an increase in population at the steady state.

How is the representative consumer's behavior affected by an increase in real taxes?

As taxes increase, consumers have less disposable income, meaning that they cannot purchase as many goods at their optimal point(incl leisure goods)

Why is the marginal product of labor diminishing?

As you gain too many workers, they have less work that can be distributed (Class example: 5 workers with 3 brooms)

Why does the base year matter in calculating real GDP?

Base year matters because relative prices change over time, and it must be used to normalize GDP, taking inflation into account

What are the two ways in which national wealth is accumulated?

Capital stock and domestic claims on foreigners (the current account surplus)

Explain what chain-weighting is.

Chain weighting is using adjacent years to calculate real GDP to calculate accurate growth from one year to the next

Why are the comovements in aggregate economic variables important?

Comovements tend to be key regularities in terms of economic variables during a business cycle.

What goods do consumers consume in this model?

Consumption good & Leisure

Describe the key business cycle regularities in consumption and investment expenditures.

Consumption is procyclical and coincident(smaller than variable real GDP), investment is procyclical and coincident(larger than variable real GDP)

What is the largest expenditure component of GDP?

Consumption with 68.4%

Explain why employment may rise or fall in response to an increase in total factor productivity.

Employment is dependent on the consumers choice of leisure (Employment=h-l in this figure), and leisure may rise or fall depending on the income/substitution effect strength of the real wage increasing

What are the key business cycle regularities in the labor market?

Employment is procyclical, lagging, and less than variable real GDP

What are the endogenous variables in the model?

Endogenous is calculated/determined within a model itself, in this case being labor demand, taxes, aggregate output, consumption, and rea wage

What is the difference between exogenous growth and endogenous growth?

Exogenous growth is growth that is created by variables outside the scope of the model(Technological advancements, savings rate), and endogenous growth is caused by variables within the odel, such as capital investment and working population/labor force

What are the exogenous variables in the model?

Exogenous variables are determined outside of the model, in this case being government spending

When did the five most recent recessions occur in the United States?

Feb 2020 to April 2020(COVID) (not accounted in textbook) 2008-2009 (HOUSING MARKET CRASH) 2001 (DOT COM BUBBLE) 1991-1992(OIL PRICE SHOCK) 1981-1982(OIL/ENERGY CRISIS) 1974-1975(OPEC OIL CRISIS)

What is the difference between GDP and GNP?

GNP measures the value of output produced by domestic factors of production, whether or not the production takes place (as is the case for GDP) inside U.S. borders.

Why does government spending crowd out private sector purchases?

Government spending has a pure negative income effect, essentially concluding that the government "competes" with the private sector. It does not completely crowd out the private sector, though, as typically there is an increase in aggregate output. (Change in consumption = change in GDP - change in government spending, according to the income-identity approach)

What is the role of the government in the one-period, closed-economy model?

Governments purchase government goods(g) via taxation and thusly providing public goods such as national defense which would be unlikely had by the private sector

Was Malthus right? Why or why not?

He was wrong, as he - Did not account for effects of increasesd capital stock on production, which is not limited as land(what his model utilizes) is. - Did not account for growth rate in terms of the opportunity cost of starting a family, leading to developed countries birth rates decreasing as more lucrative wage opportunities arise.

What can increase the standard of living in the Malthusian model?

If population growth falls in the steady state, the Malthusian model suggests that this will increase output and consumption per worker, which makes everyone better off.

Why might a decrease in taxes have no effect?

If the government reduces taxes and holds its spending constant, it must borrow more, and the government will have to increase taxes in the future to pay off this higher debt. Thus, future incomes in the private sector must fall.

How much richer was the average American in 2014 than in 1900?

In 1900, the average income for an American was $5,188 (2009 dollars), and this grew to $50,051 (2009 dollars) in 2014. Thus, the average American became almost ten times richer in real terms over the course of 114 years,

How can we discern positive and negative correlation in a time series plot? In a scatter plot?

In a time series plot, a positive correlation means that the x and y curves move together cyclically In a scatter plot, we will know depending on if the line of best fit is positive or negative

Is national defense a large fraction of government spending?

It is relatively small compared to state and local funds, making up about 23.26 percent of government expenditure

What are the key business cycle regularities with respect to the price level and inflation?

Price level is countercyclical, coincident, and smaller than variable real GDP

Explain why experimentation is difficult in macroeconomics. Why should a macroeconomic model be simple? Should a macroeconomic model be an exact description of the world? Explain why or why not.

In macroeconomics, most experiments that could be informative are simply too costly to carry out. (Shutting off all banks for a day to test a theory) All economic models are abstractions. They are not completely accurate descriptions of the world, nor are they intended to be. The purpose of an economic model is to capture the essential features of the world needed for analyzing a particular economic problem. Similar to a map

Explain why a macroeconomic model should be built from microeconomic principles.

In order to be specific and accurate to consumers and firms

How are a consumer's preferences over goods represented?

Indifference curves

Can the government run a deficit in the one-period model? Why or why not?

It cannot as there is no period of repayment included(and thusly only purchasing goods it needs currently), it would have to be multiple periods. (G-T is always 0 in one period)

Why is the income-expenditure identity important?

It helps confirm the values of the income and expenditure approaches and give us a more clear view of GDP

Why is a Cobb-Douglas production function useful for analyzing economic growth?

It is a good fit for aggregate US data and can be used as an analytical tool for growth-accounting. As well, it provides all necessary data

Why is the competitive equilibrium in this model Pareto optimal?

It is at the maximum possible point in which the indifference curve intersects with the PPF, meaning there is no way to make anyone better or worse off

Give two reasons that the unemployment rate may not measure correctly what we want it to measure.

It may be biased in terms of people being marginally attached, as well as part time workers seeking full time jobs, as well as the intensity of labor search

What does the Solow residual measure, and what are its empirical properties?

It measures total factor productivity as a residual, as it is the output that is unaccounted for after the direct effects of input capital/labor

In what sense does the Solow growth model give optimistic conclusions about the prospects for improvement in the standard of living, relative to the Malthusian model?

It proposes that, unlike the Malthusian model, consistent increases in total factor productivity, and thus standard of living are possible, so long as increases in technology continue to occur.

What are the equilibrium effects of an increase in total factor productivity?

It shifts the production function upward, increasing equilibrium. This means that output and consumption increase, the real wage increases, and leisure & employment may rise or fall(depending on income/substitution effect strength)

What are the primary defining characteristics of macroeconomics?

Macroeconomics is the study of the behavior of large collections of economic agents. It focuses on the aggregate behavior of consumers and firms, the behavior of governments, the overall level of economic activity in individual countries, the economic interactions among nations, and the effects of fiscal and monetary policy.

What are the differences and similarities among private sector saving, government saving, and national saving

National savings is the combination of private sector and government saving. public savings come from public sectors, i.e., government. Meanwhile, private savings come from private sectors, i.e., the sum of household savings and business savings.

Is GDP a good measure of economic welfare? Why or why not?

No, -aggregate GDP does not take into account how income is distributed across the individuals in the population. (Wealth inequality) - the increase in GDP exaggerates the increase in economic welfare, as GDP does not measure the value added when food is cooked at home.

What is the cause of inflation in the long run?

Over the long run, the rate at which the central bank (the Federal Reserve System in the United States) causes the stock of money to grow determines what the inflation rate is.

Does a Phillips curve relationship exist in the data set that was studied in this chapter?

Price level is countercyclical, coincident, and smaller than real GDP(reverse Philips curve)

Explain the difference between the nominal interest rate and the real interest rate.

Real interest rate is the nominal interest rate minus inflation the rate, that is, the real interest rate represents the purchasing power of that interest rate

What role did credit market imperfections play in the recent financial crisis?

Regulatory failures in the U.S. financal system created profit opportunities for excessively risky mortgage lending, and a decline in the price of housing led to a wave of mortgage foreclosures and stress in financial markets.

Explain what happens when the economy is on the bad side of the Laffer curve and the income tax rate falls.

Tax revenue will increase, as the bad side of the laffer curve(t2 and onward) implies the taxation weight is too heavy/taxes are too high to maximize revenue.

Is it a bad idea for a country to run a current account deficit? Why or why not?

The effects of a government deficit depend on what the source of the deficit is. If the deficit is the result of a decrease in taxes, then the government debt that is issued to finance the deficit will have to be paid off ultimately by higher future taxes. In the case of a government deficit resulting from higher government spending, there are always implications for aggregate economic activity, as discussed earlier in terms of the crowding out of private spending.

Explain what determines the golden rule quantity of capital per output and the golden rule savings rate.

The golden rule quantity of capital per output means that the marginal product of capital equals the depreciation rate. The golden rule savings rate is dependent on the interest rate and population growth level, such that it maximizes steady state level of growth and consumption (the real interest rate equals the rate of population growth)

Why is the index of leading economic indicators useful for forecasting GDP?

The increase or decrease of a leading variable predicts a likely path for GDP

What is the primary defining feature of business cycles?

They're fluctuations about the trend in Real GDP

What is the representative firm's goal?

To maximize profit

Explain the concept of value added.

Value added is the total revenue minus the initial product. It determins how much value is tacked on by converting an intermediate good to a final good

What is the principal effect of an increase in government spending?

We show in Chapters 5 and 11 that increased government activity in general causes a crowding out of private economic activity.

What are two striking business cycle events in the United States during the last 112 years?

World War II and the Great Depression

What is the parameter a in the production function in Equation (7-21)?

a is the fraction of national income that goes to the capital output.