Intermediate Macro Economics Exam 1 Matias Vernengo Bucknell fall 2020, intermediate macro exam one quiz, HW, class activities, intermediate Macro Economics Exam 2, inter macro final, inter macro exams 1 and 2

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Credibility and the confidence fairy

"Confidence itself is not a cause. It is the effect of things already in motion. (...) What passed as a 'lack of confidence' crisis was really nothing more than an investor's recognition of the fact that new plant facilities were not needed at the time."

money multiplier

-Money being deposited and loaned out -portion goes to reserves and rest is loaned out- loaned out money some goes to reserves rest loan out and so on and so forth formula- 1/ reserve requirment

With the nominal and real GDP find the implicit price deflator. Compute the rate of change (inflation) in prices between 1960 and 1970, 1970 and 1980, 2000 and 2010, and 1960 and 2019.

. I downloaded Nominal and Real GDP, shown in the graph, and divided the former by the latter to obtain the GDP price deflator. You can download it directly too. Remember a real variable is the nominal divided by the price index, in this case y=Y/P, where y stands for real GDP and Y for nominal. That's a convention in macroeconomics. I'll use annual data, and instead of 2020, since I don't have the annual data for 2020, 2019. Note that I changed that above. Formula 100 * (P70 - P60)/P60 = 30.3% 100 * (P80 - P70)/P70 = 95.0% 100 * (P10 - P00)/P00 = 23.1% 100 * (P19 - P60)/P60 = 575.2

Consider an economy described by the following equations: C = 200 + 0.75(Y - T) I = 500 G = 200 T= 0.2Y M = 2150 L = Y - 2000r Note that we assume that P equals one. Find the value of r.

Marginal Productivity of Capital (MPK)

.chapter 3 Factors of production are paid according to their productivity, that is, their contribution to the productive process. Distribution of income is the result of the working of supply and demand formula change in output/change in capital

multiplier formula

1/(1-MPC) or 1/MPS It may be 1/(1-c) 1-MPC = MPS

If the level of income is $3,000, the money supply is $1,400, and the money demand function is given by L = 0.5Y - 1,000r (so P=1), then the rate of interest would be 2 a) 5% b) 10% c) 20% d) none of the above

10% M = L 1,400 = 0.5(3,000) - 1,000r 1,000r = 1,500 - 1,400 R = 100/1,000 = 0.1 = 10%

Consider an economy described by the following equations: C = 200 + 0.75(Y - T) I = 500 G = 200 T= 0.2Y M = 2150 L = Y - 2000r Note that we assume that P equals one. Find the equilibrium value of Y.

2250

If the economy is described by the following functions C = 250 + 0.75 (Y - T) I = 100 G = 400 T = 100 Find the value of the multiplier

If the economy is described by the following functions C = 250 + 0.5 (Y - T) I = 100 G = 100 T = 100 Then GDP would be equal to a) 700 b) 800 c) 900 d) 400

800 Y = C + I + G = 250 + 0.5Y - 50 + 100 +100 Y - 0.5Y = 400 Y = 400/0.5 = 800

. Monetarists, New Classicals and New Keynesians agree that a) The business cycle is a deviation from the natural rate X b) That the natural rate of unemployment is a weak attractor to the economy c) Do not agree on anything d) None of the above

. The IS curve is flatter the a) More elastic is investment with regards to the rate of interest b) More elastic is investment with regards to income level c) Less elastic is investment concerning the rate of interest d) Less elastic is investment concerning income level

According to Friedman, the Phillips curve Select one: a. Is vertical in the long-run b. Is stable in the short-run c. Is horizontal in the short-run d. Can be exploited for policy purposes

According to Keynes Debt-deflation effects imply a) Lower prices, higher real debt, lower investment, and the IS moves down and to the left b) Lower prices, higher real debt, higher investment, and the IS moves up and to the right c) Lower prices, lower real debt, higher investment, and the IS moves down and to the left d) Lower prices, higher real debt, lower investment, and the IS moves up and to the right

Assume an accelerationist version of the Phillips Curve written as follows: If inflation in the past was 0.02, and the natural rate of unemployment is 0.05. What would inflation be if unemployment increases to 0.08 and the coefficient beta is 0.5? Select one: a. Inflation falls to 0.05 b. There would be price stability (no inflation) c. There would be deflation of -0.05 d. Inflation remains the same

Demand-pull and cost-push theories of inflation provide alternative views of the Great Inflation of the 1970s. Select one: a. Cost-push theories emphasize the role of wage resistance in the inflationary process b. Cost-push theories see inflation as a monetary phenomenon c. Demand-pull theories suggest that inflation was a real phenomenon d. Demand-pull theories suggested that the Oil Shocks were the central cause

For Keynes the interest rate a. Tends to the natural rate b. Is a real phenomenon dependent on intertemporal consumer preferences c. None of the others d. Equilibrates savings and investment

For classical authors (Smith, Ricardo) Say's Law implied a. That everything that was saved was automatically invested b. Full employment of labor c. That income equilibrated investment and savings d. That the rate of interest equilibrated investment and savings

For the Efficient Market Hypothesis Select one: a. Agents are rational and use all available information b. You can beat markets c. Instability and bubbles are the norm in capitalism d. All the other replies

Hysteresis implies that Select one: a. The natural rate of unemployment changes with the actual unemployment level b. None of the other c. The natural rate of unemployment does not exist d. The natural rate is fixed and there could be no deviation in the long run

If a shock occurs as shown in the figure. Then Select one: a. All the other replies b. A real shock would cause inflation c. The low bank or monetary rate causes excess investment and inflation d. The bank rate would have to be brought back to equilibrium with the natural interest rate to stop inflation

If the international interest rate (r*) goes up, and the economy is in a flexible exchange rate system a) The economy would move from point 1 to point 3 b) The economy would move from point 1 to point 2 c) The economy would stay in point 1 d) None of the above

In Friedman's theory, if the government announces expansionary monetary policy, then a. The economy moves from 1 to 3, and then to 4 b. The economy moves from 1 to 2, and then back to 1 c. The economy moves from 1 to 3, and then back to 1 d. The economy moves from 1 to 4

In the Wicksellian model Select one: a. Both real and monetary cycles could occur, but he believed real shocks were more relevant b. There is no natural rate of interest c. An increase in the marginal productivity of capital caused deflation d. The bank and the natural rate of interest are always different

In the neoclassical model a. All the other replies b. A fall in natural output could be caused by a negative technological shock c. A fall in natural output could be caused by a decrease in workers' preferences for leisure d. A fall in natural output could be caused by a decrease in money supply

Keynes did not believe in the equilibrium in the labor market because a. Workers would not work less if the real wage fell b. Labor demand is not related to the marginal productivity of labor c. Workers are lazy d. He disliked the idea of equilibrium

Monetarists, New Classicals and New Keynesians agree that Select one: a. All the other replies b. The business cycle is a deviation from the natural output level c. Shocks are the main cause of the cycle d. There is a natural rate of unemployment

Real Business Cycles (RBC) authors argue that Select one: a. Business cycles result from changes in factor endowments, technology or preferences b. Output is mean reverting, and cycles are deviations from the optimal output level c. Business cycles are the result of imperfections d. All the other replies

Real Business Cycles theory implies that Select one: a. Real wages are pro-cyclical b. Productivity is anti-cyclical c. All the other replies

The IS curve is flatter the a. The less elastic is money demand with regards to the rate of interest b. The less elastic is investment with regards to the rate of interest c. The larger the size of the multiplier d. None of the others

The LM curve a. is positively sloped because money demand is positively related to the level of income b. is flat because economic agents expect the rate of interest to fall c. is vertical because money demand is insensitive to changes in income d. is negatively sloped because money demand is negatively related to the level of income

The LM provides a) The interest rate, which guarantees equilibrium in the money market b) The level of income, which guarantee equilibrium in the money market c) The level of income, which guarantee equilibrium in the goods market 2 d) The interest rate, which guarantees equilibrium in the goods market

The Rational Expectations Hypothesis (REH) implies Select one: a. Economic agents use all information to form expectations b. Markets may remain in disequilibrium for prolonged periods in the absence of government intervention c. Economic agents make no mistakes d. The economy moves slowly to the natural rate of unemployment after an unexpected shock

The Solow growth model assumes that a) Technology is exogenous b) Technology is shows increasing returns to scale c) Technology does not affect growth d) All of the above

The defenders of the Treasury View argued a. that fiscal deficits crowd out private investment b. all of the above c. printing money would be preferable than fiscal deficits d. that deficits have a small impact on output and employment

The efficiency wage model Select one: a. All of the other b. Implies that involuntary unemployment is possible as a result of a real rigidity c. Implies that the elasticity of effort with respect to the nominal wage is one d. Involuntary unemployment is possible

The efficiency wage model a) Is the most important real rigidity model X b) Shows that firms must pay less to obtain more effort from workers c) Implies that the elasticity of effort with respect to the real wage is zero d) None of the above

The financial accelerator implies that Select one: a. When a firm's balance sheets deteriorate, banks demand a higher interest to compensate for risk b. The financial system is anti-cyclical and amplifies the booms and busts, leading to bubbles c. All of the other replies d. The costs of credit intermediation remain the same during the cycle

The main difference between Gross Domestic Product (GDP) and Gross National Product (GNP) is that a) GDP is produced within the country's borders, while GNP is produced by national firms b) In GDP we discount the depreciation of capital goods c) GDP does not measure intermediate sales from one firm to another, but GNP does d) All of the above

The multiplier-accelerator theories of the cycle imply that a) The economy fluctuates endogenously around a suboptimal output level b) Technological change is the main cause of the business cycle c) Monetary shocks are irrelevant for the economic cycles d) That capitalist economies are inherently stable

The neoclassical dichotomy means that a. Money is neutral b. Money affects the level of output c. Money is endogenous d. Savings and investment are equal at full employment level

n the island model if the central bank announces an increase in money supply Select one: a. Information would be costly and output and prices would go up b. Information is costly and output would deviate permanently from the natural level c. Information is freely available and output would deviate permanently from the natural level d. Information is freely available and prices would go up

The Liquidity Trap is a situation in which a) economic agents might expect that interest rates will increase b) economic agents might expect that the price of bonds will fall c) economic agents choose to hold liquidity in the face of an uncertain future d) all of the above

A liquidity trap is a situation in which the interest rate is very low. Agents expect the normal interest rate to be higher and eventually to go up. Since the interest rate on bonds is inversely related to the price of bonds, if they expect the interest paid by bonds to go up, they also expect the price to go down. In that situation, given that they are pessimistic about holding bonds, agents will opt for holding cash (money), that is the most liquid asset.

What are the reasons Keynes used to suggest that even with flexible prices the economic system would not tend to full employment? Explain

Again, there are two possible mechanisms. The debt-deflation effect implies that lower prices would increase the real burden of debt, and that would affect negatively both investment and consumption. In addition, Keynes suggests that there is a negative income distribution effect, which implies that real wages (w/p) would tend to fall during a recession, with wages falling more than prices, and that would have a negative impact on the relatively poor that have a higher propensity to consume. In that case, with worsening income distribution consumption would fall, and the recession would worsen.

paradox of thrift

An example of a fallacy of composition would be that at the individual level increased savings leads to additional wealth, but at the aggregate level it may reduce income. If everybody saves more and consumes less, then income for the economy as a whole, that depends on consumption behavior, would fall. This is something Keynes referred to as the paradox of thrift;

An increase in money supply, everything else constant, would have what effect on the LM curve? What would happen with the level of output?

An increase in money supply, for a given demand for money, would generate excess supply in the money market, and it would reduce the rate of interest. The effect would be a move of the LM curve down and to the right, and for a negatively sloped IS an increase in income.

note

Anytime we need a marginal product take the partial derivative in what we are looking for example assignment #2

. The Keynes' effect implies that a) That deflation is harmful for the economy b) That lower prices, reduce money demand, decrease the interest rate, and increase output c) The economic system does not have a tendency to full employment d) All of the above

According to New Keynesian authors Select one: a. The natural rate of unemployment is variable b. All the other c. Involuntary unemployment is possible with rational expectations d. The economy moves slowly to the natural rate of unemployment after a shock

Assume the economy displays hysteresis, and that this property is represented by unt = unt−1 + 0.5(ut−1 - unt−1) If unemployment was 4% in the previous period, and shoots up to 8% as a result of a recession, and the natural rate was 4%, what would be the new natural rate in two periods, if actual unemployment does not change. Select one: a. 8% b. 7% c. 6% d. 3%

For Kalecki if the share of wages in total income increased, and for the same level of autonomous investment a. Output and total profits would decrease b. Output would increase, and total profits would remain the same c. Output and total profits would increase d. Output would increase, but total profits would decrease

For Keynes the interest rate a) Equilibrates savings and investment b) Is a monetary phenomenon dependent on liquidity preference c) Affects the consumption function d) Affects the money supply schedule

Hyman Minsky suggests that financial crises are the result Select one: a. Competition among firms b. All of the other replies c. Financial innovations d. Lack of government regulation

If the output gap were negative, then according to the divine coincidence the gap between inflation and target inflation would be: a) Nil b) Positive c) Negative d) None of the above

Real Business Cycle (RBC) authors Select one: a. Believe the cycle is a disequilibrium phenomenon b. Argue that the cycle is a deviation of the optimal output level c. None of the other replies d. Argue that the cycle is a deviation from the optimal output level

Suppose that an economy is initially in long-run equilibrium with zero inflation and at the natural rate of unemployment, as shown in the following figure. Assume that the labor force totals 100 million people. Assume further that the following is the aggregate production function: Y = 100,000N, where Y is real GDP in US$, and N is the number of employed labor. The equilibrium level of output Yn would be Select one: a. 9.6 trillion dollars b. 9.4 trillion dollars c. 10 trillion dollars d. 9.2 trillion dollars

The Keynes' effect implies that when the economy is at less than full employment and prices fall a. Decreasing the real money balances, reducing the interest rate and shifting the LM to the left b. Increasing the real money balances, reducing the interest rate and shifting the LM to the right c. Decreasing the real money balances, increasing the interest rate and shifting the IS to the left d. Increasing the real money balances, reducing the interest rate and shifting the IS to the right

The LM will be flatter a) The more sensitive money demand is to changes in income b) The more sensitive money demand is to the rate of interest c) The more sensitive money supply is to changes in income d) None of the above

The debt-deflation effect implies that a. The LM curve would move up and to the left b. The IS curve would move down and to the left c. The IS curve would move up and to the right d. The LM curve would move down and to the right

The multiplier for an open economy, everything else constant, would be a) Bigger than the closed economy multiplier b) Bigger, the smaller the marginal propensity to import c) Bigger, the smaller the marginal propensity to consume d) The same as the closed economy multiplier with no government

ccording to Real Business Cycle (RBC) authors real wages are pro-cyclical, and given that real wages increase only mildly in a boom, they must assume that Select one: a. Labor demand is very elastic to changes in real wages b. Labor supply is very elastic to changes in real wages c. Labor supply is very inelastic to changes in real wages d. The labor supply schedule is flat

A negatively sloped yield curve indicates, according to the Taylor rule, that a) The economy is booming b) Inflationary expectations are high c) A recession is likely d) The output is at the natural level

According to Public Choice Theory a) Liberal governments would lead to higher government spending and deficits b) Conservative governments would lead to higher government spending and deficits 5 c) All politicians would want to be reelected and would increase spending and promote higher deficits d) All politicians would want to be reelected and would reduce spending and control inflation

According to Public Choice Theory a) Liberal governments would lead to higher government spending and deficits b) Conservative governments would lead to higher government spending and deficits c) All politicians would want to be reelected and would increase spending and promote higher deficits d) All politicians would want to be reelected and would reduce spending and control inflation

According to the Solow model there is capital deepening a) When the economy is at the steady-state b) When the capital stock grows exactly at the pace that allows its ratio to labor to be constant c) When the capital-to-labor ratio is growing d) None of the above

According to the accelerator theory, firms invest Select one: a. If expected demand is growing b. To maintain a normal level of capacity utilization c. All the other replies d. To adjust productive capacity to growing demand

Asymmetric information may cause Select one: a. Inefficiencies in the credit markets because creditors don't know borrowers' ability to repay b. Inefficiencies in the labor market because of the cost of monitoring workers c. All the other replies d. Perverse incentives that encourage borrowers to engage in riskier behavior

For Keynes macroeconomics is . No different than microeconomics b. The aggregation of the behavior of rational economic agents c. Represented by a fallacy of composition, since the whole is more than its individual parts d. None of the other replies

For an expected increase in money supply (M), according to the Monetarist model a) The economy would move from point 1 to point 4 directly b) The economy would move from point 1 to point 2 and then to point 4 c) The economy would move from point 1 to point 3 and then to point 4 d) None of the above

If the economy is beyond the natural rate of output (Yn), according to Friedman a) Prices would rise, real money balances would rise and the LM would move up and to the left b) Prices would rise, real money balances would fall and the LM would move up and to the right c) Prices would rise, real money balances would fall and the LM would move up and to the left d) Prices would rise, real money balances would rise and the LM would move up and to the right

If you have a situation like the one in the figure What would be the effect on the economy of the Pigou effect? Select one: a. Both the IS and the LM would move to the right until the economy is at Yn b. Nothing would change c. The IS curve would move up until the economy is at Yn d. The LM curve would move down until the economy is at Yn

In Robinson's model it is possible for a) An increase in the wage share implies higher consumption and lower growth b) An increase in the profit share to stimulate investment and lead to lower growth c) For growth to be associated with higher and lower shares of wages in total income d) None of the above

In the Kaleckian model, if the share of wages in total income rises, and for the same level of autonomous investment a) Output would increase, but total profits would decrease b) Output and total profits would decrease c) Output would increase, and total profits would remain the same d) None of the above

Mark the stock variable a) Savings b) Investment c) Bonds d) Wage share

Real Business Cycle (RBC) authors think that the Great Depression was caused Select one: a. By a monetary contraction caused by the Fed b. The collapse of a housing and commodity bubble c. Hoover's labor regulations that led to a disincentive to work d. The crash of Wall Street

The Great Depression was a. caused by a monetary contraction, according to Friedman b. All of the other c. caused by the contraction of consumption, associated to the burden of debt, according to Keynes d. made worse by the New Deal, according to RBC authors

The Keynesian Phillips Curve implies that Select one: a. That the PC is vertical in the long run b. That the natural rate of unemployment is fixed c. There is a stable tradeoff between inflation and unemployment d. That the tradeoff cannot be used for policy purposes, otherwise inflation would accelerate

The Solow growth model implies that higher savings a) Leads to an increase in the capital-labor ratio and higher growth b) Increases the rate of interest and economic growth c) Determines investment and does not affect growth d) None of the above

The efficiency wage model a) Implies that involuntary unemployment is not possible b) Shows that firms must pay less to obtain more effort from workers c) Implies that the elasticity of effort with respect to the real wage is one d) None of the above

Which one is a stock variable? a. The amount of Treasury bonds held by the Federal Reserve b. The wealth held in real estate in the United States c. All of the other d. Checking account deposits

according to the Financial Fragility Hypothesis Select one: a. Only a shock would lead to financial instability b. There are three kinds of financial structure: covered, uncovered and Ponzi c. There are three kinds of financial structure: hedge, speculative and Ponzi d. Bubbles and Ponzi schemes cannot occur

the fundamental national identity equation

C+S+T=Y=C+I+G

What explains the fluctuation of the level of output and employment in the simple neoclassical model?

Changes in the production function or in the preferences of workers.

Gross National Disposable Income (NI)

Chapter 1 -NI is equal to GDP, the Net Factor Payments to the Rest of the World (NPRW), Current Transfers (CT), and terms of trade effects (TTE),which represents the relative price of the goods and services exported by the country over the price of the imported goods and services. NI = GDP+NPRW+CT+TTE

wicksellian Model

Chapter 4 -heavily influences modern neoclassical econ -allows us to look at the effects of real and monetary shocks -One difference between Wicksell's model and the QTM discussed in the previous chapter is that he assumed that central banks set the basic rate of interest, and were not directly concerned with the quantity of money in circulation

. In the neoclassical model a) A fall in natural output couldn't be caused by a hike in workers' preferences for leisure b) A fall in natural output couldn't be caused by a negative technological shock c) A fall in natural output could be caused by a decrease in money supply d) None of the above

A Real Business Cycle (RBC) and a New Keynesian (NK) macroeconomist might see the COVID recession in different light. Select one: a. It would show money is neutral for the NK one, and that money has real effects for the RBC one b. None of the other replies c. It would a demand shock for the RBC one, and a supply shock for the NK one d. It would a demand shock for the NK one, and a supply shock for the RBC one

A competitive, profit maximizing firm hires workers until a. The real wage equals the real rate of profit b. Marginal productivity of labor equals the nominal wage c. All the other replies d. Marginal productivity of labor equals the real wage

According to Hyman Minsky a) Stability is positive and promotes financial innovation b) Firms move from hedge to speculative, and then to Ponzi financial structures c) Financial crises are more probable in a deregulated financial environment d) All of the above

Cost-push theories of inflation imply that a) Wage bargaining and class conflict are central for the acceleration of inflation b) The Vietnam War was not a central cause of inflation c) Positive oil shocks explain inflation in the 1970s d) All of the above

Expansionary fiscal policy would a. Have no impact on the rate of interest or output b. Move the LM curve right and up c. Move the IS curve left and up d. Increase output, but also the rate of interest

Fiscal policy is completely ineffective a. In the liquidity trap case when the IS is flat b. In the crowding out case when the IS is vertical c. In the crowding out case when the LM is vertical d. In the liquidity trap case when the LM is flat

For Keynes involuntary unemployment a) Does not results from disequilibrium in the labor market b) Might not be eliminated by market forces with flexible prices c) Results from lack of aggregate demand d) All of the above

For New Keynesian authors a) The natural rate of unemployment is variable b) Involuntary unemployment is possible with rational expectations c) Involuntary unemployment is a result of the power of union members d) All of the above X

Functional finance authors argue that debt a) Is dangerous and results from excessive spending by self-interested politicians b) That debt-to-GDP ratios beyond a certain threshold are unsustainable c) Is fine if fiscal deficits are of the size required to produce full employment d) That debt is sustainable if the rate of growth of the economy is higher than the rate of interest

GDP can be seen measured in three different ways, namely a) Consumption, demand, and income b) Value added, investment and government spending c) Money supply, money demand and the interest rate d) None of the above

GDP includes a. All final goods b. None of the other replies c. All final services d. All final goods and services

Given Lucas aggregate supply curve [Ys = Yn + alpha(P - Pe)] what would be the effect of an unexpected increase in the price of oil in international markets Select one: a. A recession with a decrease in prices b. A boom with a decrease in prices c. A boom with an increase in prices d. A recession with an increase in prices

In terms of the Phillips Curve, what Friedman suggested is that inflation would accelerate if Select one: a. Actual unemployment was above the natural rate of unemployment b. Actual unemployment was higher than the natural rate of unemployment c. Actual unemployment was the same as the natural rate of unemployment d. Actual unemployment was below the natural rate of unemployment

Investment a) Determines output through the multiplier b) Is determined by previous changes in income c) Is the flow increase of capital d) All of the above

Keynes thought that a. That unemployment was always voluntary or frictional b. The economic system had a tendency to full employment c. The economic system was stable d. Financial markets behaved like a beauty contest

The Real Bills Doctrine implies that a. That money supply determines prices b. That inflation results from the behavior of the central bank c. That inflation is caused by printing money d. That the amount of money depends on the real activities of the economy

The difference between the Keynesian and Kaleckian multiplier is that a. The marginal propensity to consume is one in the Keynesian version b. None of the other replies c. Income distribution is relevant in the Keynesian version d. Stability depends on the psychological law in the Keynesian version

The real balance effect a) Suggests that wealth effects would lead to full employment b) Implies that lower prices, increase wealth, and dislocate the IS up and to the right c) Are central for neoclassical economics d) All of the above

What would be the income of a worker that made $40,000 in 2012 in real terms in 2020? a. 60,000 b. 47,000 c. 52,700 d. 57,200

he multiplier-accelerator mechanism implies that Select one: a. Technological change is the main cause of the business cycle b. That capitalist economies are inherently stable c. Monetary shocks are irrelevant for the economic cycles d. The economy fluctuates endogenously around a suboptimal output level

And fiscal and monetary polics ISLM (in graph notes part of the study guide)

Fiscal and monetary can compensate the negative the demand shocks discussed before. If one opts for expansionary fiscal policy the IS curve would move up and to the right. The consequence is higher level of income, but it comes at a price, since the rate of interest goes up. This leads to some reduction of private investment, and partial crowding out; Expansionary monetary policy would move the LM curve down and to the right. That would lead to lower interest rates and additional investment by private agents. A problem would exist when the rate of interest cannot be reduced any further as in the so- called Liquidity Trap, or when the Zero Lower Bound (ZLB) interest rate has been reached.

If GDP is 17,000, income receipts from the rest of the world are 1,000, and income payments to the rest of the world are 500 (all in billions of dollars), then what would GNP be? a) 17,500 X b) 16,500 c) 18,500 d) none of the above

GDP + income receipts from the rest of the world - income payments to the rest of the world = GNP GNP = 17,000 + 1000 - 500 = 17,500

Spending Mutiplier

Goverment spends money- it becomes someone's income and they save some and spend the rest. Then that beomes somone else income and save and spend and so on and so forth. -basically inital change in spending causes ripple effect throughout economy leads to more total spending 1/mps or 1/(1-mpc)

corwding out

Government spending makes private investing go down.

Go to the website of the Bureau of Labor Statistics and find the data on unemployment for the civilian labor force and the participation rate since early 2000s (it is also available in FRED). Compare two different types of unemployment (e.g. differences by race and ethnicity, or by the attachment to the labor market). Is the official unemployment measure (U3) the best measure of unemployment?

Here a graph with unemployment and the participation rate. Note that after the 2007-9 recession the falling rate of unemployment goes hand in hand with lower participation rates. That implies that the improvement in the labor market results from more people getting discouraged that they could not find jobs, and leaving the

assignment 1 question 1 1. With the nominal and real GDP find the implicit price deflator. Compute the rate of change (inflation) in prices between 1960 and 1970, 1970 and 1980, 2000 and 2010, and 1960 and 2019.

I downloaded Nominal and Real GDP, shown in the graph, and divided the former by the latter to obtain the GDP price deflator. You can download it directly too. Remember a real variable is the nominal divided by the price index, in this case y=Y/P, where y stands for real GDP and Y for nominal. That's a convention in macroeconomics. I'll use annual data, and instead of 2020, since I don't have the annual data for 2020, 2019. Note that I changed that above. Formula 100 * (P70 - P60)/P60 = 30.3% 100 * (P80 - P70)/P70 = 95.0% 100 * (P10 - P00)/P00 = 23.1% 100 * (P19 - P60)/P60 = 575.2%

note in

IN the IS we solve for Y In the LM we solve for R

How would the slope of the IS curve change if investment became more sensitive to changes in the rate of interest? Explain.

If investment is more sensitive to change in the rate of interest, and the investment schedule is flatter, then the IS would also be flatter, since a higher investment, with a lower interest rate, would lead to a higher level of income through the multiplier.

Explain, using Lucas Aggregate Supply curve, why money is neutral when monetary changes are expected, but unexpected changes in money supply would have an effect on the level of activity. assignemtn 5

If monetary policy is announced an expected, then the increase in money supply (M) would lead to inflation, with the economy at full employment (at the natural level, Yn). Agents would know this and increase their expected price (Pe), which would remain in equilibrium with the actual price. However, if the increase in money supply were unexpected, they would not be sure if the increase in prices is the result of excess demand, or an increase of the demand for their product, and output would increase temporarily, since P > Pe.

Assume the aggregate supply curve Ys is given by: Ys = 3000 + 10(P - Pe), and Pe = 100 What would be the level of output if the economy were at the natural rate? If for some unanticipated reason the expected price increased to 125, then what would be the new aggregate supply level, if the economy started from equilibrium? assignment 5

If the economy is at the natural output level then Ys must be equal to Yn, which is given at 3000, and that requires that the actual price level is at the expected price level so that P equals 100. If the expected price increased to 125, then the price gap would be -25, and the new Ys would be: Ys = 3000 + 10 (-25) = 2750 An unexpected supply side shock would cause a recession.

Hysteresis & the natural rate

In hysteresis models the natural rate of unemployment will increase if the actual rate of unemployment in the previous period exceeds the former time period's natural rate; ■ This can be expressed as follows: • Unt = Unt−1 + a(Ut−1 -Unt−1) + bt ■ The shifting actual rate of unemployment acts like a magnet, pulling the natural rate of unemployment in the same direction. Thus while it may be reasonable to argue that aggregate demand does not affect Un in the short run, it is likely that prolonged periods of abnormally high or low economic activity will shift the natural rate of unemployment.

Lucas and Rational Expectations

Krugman suggests that the Monetarist Revolution redressed an excessive Keynesianism of the 1960s policies, and that the New Classical Revolution of Lucas has moved too far in the other direction. ■ Rational expectations models implied that with full information the economy would not deviate from the natural rate not even in the short run. The Phillips Curve would be vertical in the short run. ■ This proposition basically implies that if the Fed announces that it will contract money supply (or hike the rate of interest) to reduce demand, then inflation would fall without leading to higher unemployment.

Liquidity Preference Theory

Liquidity preference theory is a model that suggests that an investor should demand a higher interest rate or premium on securities with long-term maturities that carry greater risk because, all other factors being equal, investors prefer cash or other highly liquid holdings. -basically people like to have their money in things that are liquid

tax multiplier formula

MPC/MPS -TAX MULTIPLER WILL ALWYAYS BE ONE LESS THEN THE SPENDING MULTIPLER

Monetarists principles

Monetarists believe in three basic neoclassical principles: (1) Prices and wages are perfectly flexible. However, perfect information does not exist; (2) Changes in aggregate demand do not affect real output in the long run, but they do affect real output in the short run; -(3) Fluctuations in the money supply drive fluctuations in aggregate demand and are responsible for business cycles.

Is there a trade off between inflation and unemployment?

PP1 -Many macroeconomists, do think so. The negative relation is referred to as the Phillips Curve, and we will discuss it in the course;

equilibrium of ISLM curve

PPT 6 Chapter 6 The intersection of the IS and LM curves allows us to find the equilibrium values of output and the rate of interest, and the simultaneous equilibrium in the goods and services and money markets.

Debt- deflation spiral

PPT 7 chapter 7 Keynes said that: "if the fall of wages and prices goes far, the embarrassment of those entrepreneurs who are heavily indebted may soon reach the point of insolvency, — with severely adverse effects on investment." If prices fall, indebted agents owe in real terms more than before; P↓⟹ Debt/P↑⟹ I ↓⟹ Y↓ If the Debt-Deflation Effect is stronger than the Real Balance Effect, then the system would not move towards full employment in the long run, even with price flexibility

ISLM with price flexibility and debt

PPT 8 The ISLM model suggests that equilibrium in the goods market and money market can be achieved simultaneously with involuntary unemployment, along Keynesian lines; Whenever the economy is below full employment in the labor market, and the level of output is below its full capacity level (natural in the neoclassical model), both according to the Keynesian and neoclassical models, there would be a tendency for wages and prices to fall; We will assume that debt (D) has an impact on autonomous consumption (Ca) and investment (Ia), and that autonomous spending (A) is affected positively by access to credit. We will also assume that wealth affects autonomous consumption.

Pigou effect

PPT 8 Pigou argued that, as prices fall, the real wealth of economic agents increases, and, as a result, their consumption - in our model it would be autonomous consumption (Ca) - would increase; With lower prices the same amount of nominal wealth would allow consumers to spend more, and the level of income would expand. We have: P ↓⟹ wealth/P↑⟹ Ca ↑⟹ Y↑ The Keynes and Pigou Effects together rely on the effects of real monetary and wealth balances on spending to bring the economy back to the natural rate, and the joint effect is often referred to as the Real Balance Effect; Note that while the Keynes Effect might not be sufficient to bring the economy back to full employment if the rate of interest cannot fall below the zero lower bound for the nominal interest rate, or by a Liquidity Trap, that is not the case for the Pigou Effect.

neoclassical dichotomy

Real variables are determined by the supply-side (output, employment, real wage, and real rate of interest); ■ Monetary variables have effects only on the price level; ■ Markets produce optimal outcomes and price flexibility creates the conditions for the absence of involuntary unemployment.

what is the difference between Say's Law and the Principle of Effective Demand when it comes to the relation between Savings and Investment?

Say's Law implies that savings determines investment. In the neoclassical version with full utilization of resources. The Principle of Effective Demand puts causality upside down with investment determining savings.

If output is at the optimal (natural, according to neoclassical theory) level (Yn= 100), the Marshallian constant is k=1/4, and the money supply is M = 50, then what would be the price level? What would be the price level is M = 25, according to the Quantity Theory of Money? Can changes in money affect the level of output and cause a crisis in the neoclassical model? Explain.

Starting from M=kPY and substituting the values of Yn for Y we obtain P=2. If M=25 then P=1. So changes in money supply affect only prices in the neoclassical model, since output is determined by the production function and the equilibrium in factor markets.

Assume that an economy has the following Cobb-Douglas production function: Calculate the Marginal Productivity of Labor (MPN) when N = 1, N =4, N = 9, N = 16, N = 25. Assume that capital is constant at K = 1. Is MPN decreasing as N increases?

Taking the partial derivative of Y with respect to N to obtain the MPN we get: �� = 1 2 �(/* �(/* And substituting the values for K and N, we obtain: MPN(1)=1/2; MPN(4)=1/4; MPN(9)=1/6; MPN(16)=1/8; MPN(25)=1/10. MPN is positive and decreasing.

Neoclassical Synthesis Keynesians and Monetarists

The 1950s and early 1960s were the pinnacle of Keynesian influence both from a theoretical and policy perspective. Not only did Keynesian theory dominate macroeconomic theory, but Kennedy's election in 1960 was quickly followed by many of his Keynesian professors from Harvard moving with him to Washington. ■ Milton Friedman was the father of Monetarism. Monetarists have the following goal: reassert neoclassical principles or neoclassical models to explain business cycles. ■ A critical component of this neoclassical Monetarist model is the fact that it accepts the neoclassical principle of money neutrality.

Slope of LM Curve

The LM curve is normally represented as being positively sloped in the interest rate and income plane, for an increase in the level of income raises the demand for money, which in turn raises the rate of interest that equilibrates the money market; The LM will be flatter (steeper) the less (more) sensitive money demand is to changes in income and the more (less) sensitive money demand is to the rate of interest.

Okun's Law

The generalization that any 1-percentage-point rise in the unemployment rate above the full-employment unemployment rate will increase the GDP gap by 2 percent of the potential output (GDP) of the economy.

Show graphically the effect of an increase in government spending in the neoclassical model.

The increase in government spending (G) not financed by taxes (T) would lead to an increase in the rate of interest and a reduction of private investment (I), that is, crowding out would be the result.

What is the multiplier effect?

The multiplier effect, created by the reserve requirements placed on members of the Federal Reserve System, refers to the fact that small changes in bank deposits result in large changes in the money supply.

Suppose that a worker made $15,000 in 1960 and $65,000 in 2019. Using the implicit price deflator as a price index, calculate whether the worker's real income has increased or declined over this period.

There are many ways you can calculate how much 15,000 would be in 2019 or vice versa, how much 65,000 would be in 1960 dollars. One way is to use this formula: 15,000 * P19/P60 = 101,287.20 So, his income of 15,000 in 1960 would correspond to considerably more in 2019, and his income has been reduced.

Use the ISLM model, and assume that the economy is below full employment. Explain the mechanism by which the economy would move to its full employment output level when prices are flexible.

There are two possible mechanisms the Keynes and Pigou effects. The Keynes effect implies that with the fall of prices and wages, resulting from unemployment, the real amount of money (M/p) would increase, and that would lead to a lower interest rate, and higher investment and output. The LM would move. The Pigou effect implies that with lower prices, the real amount of accumulated wealth would go up, and assuming wealth affects autonomous consumption, then you would have higher consumption. The IS would move.

Consider the whole economy described by the following equations. P is fixed at 1. C = 100 + 0.75(Y - T) I = 50 - 1000r G = 50 T = 0.2Y M = 1000 L = P(2Y - 2500r) Find the IS, the LM and the equilibrium values of Y and r. Is it be possible to further stimulate the economy by increasing money supply? Explain.

To obtain the IS start with the equilibrium in the goods market: Y = C + I + G or: Y = 100 + 0.75 (Y - 0.2Y) + 50 - 1000r + 50 Y = 200 + 0.75Y - 0.15y - 1000r Y - 0.6Y = 200 - 1000r Y = (200 - 1000r)/0.4 Y = 500 - 2500r In order to obtain the LM start with the equilibrium in the money market, M = L. We obtain: 1000 = 2Y - 2500r Solving for r, we have: r = (2Y - 1000)/2500 To solve for Y we substitute the LM into the IS. We have: Y = 500 - 2500 [(2Y - 10000)/2500] Y = 500 - 2Y + 1000 3Y = 1500 Y = 500 Finally, to find r, we substitute Y into the LM. We have r = [2(500) - 1000]/2500 r = 0/2500 = 0 An increase in money supply would bring the interest rate below the lower zero bound (LZB) and would be unlikely to stimulate the economy

GDP can be seen measured in three different ways, namely a. value added, demand, and income b. consumption, investment and government spending c. money supply, money demand and the interest rate d. all of the above

Which one is a component of GDP Select one: a. Consumption of cars b. Checking deposits c. Both consumption of cars and checking deposits d. Helping your kid with homework

Given Lucas aggregate supply curve [Ys = Yn + a(P - Pe)] what would be the effect of an unexpected decrease in the price of oil in international markets

a) A recession with an increase in prices b) A boom with an increase in prices c) A boom with a decrease in prices d) A recession with a decrease in prices C

RBC authors argue that:

a) Business cycles result from changes in factor endowments, technology or preferences b) Output follows a random walk c) Business cycles are the result of rational decisions by economic agents d) All of the above D

Investment

a) Determines output through the accelerator b) Is determined by previous changes in income c) Is the stock of capital d) None of the above B

Minsky suggests that financial crises are the result

a) Financial innovations b) Lack of competition c) Regulation d) All of the above A

According to the Keynesian Phillips Curve, a decrease in unemployment is expected to be accompanied by

a) Higher labor-force participation b) An increase inflation c) An increase in the productivity of capital d) An increase in the government deficit B

The efficiency wage model

a) Is the most important real rigidity model X b) Shows that firms must pay less to obtain more effort from workers c) Implies that the elasticity of effort with respect to the real wage is zero d) None of the above It can only be a), since the efficiency wage model implies that firms need to pay more to obtain higher effort from workers, but since that only works up to a point, firms should minimize the real wage to effort relation. That implies that at the minimum the elasticity of effort with respect to the real wage is one, the so-called Solow Condition.

The Efficient Market Hypothesis

a) Is the same as the Rational Expectations Hypothesis 3 b) Implies that there are no bubbles c) You cannot beat markets d) All of the above D

According to Solow/Samuelson (Keynesians), the Phillips curve

a) Is vertical in the short-run b) Is horizontal in the long-run c) Is stable and you can only get lower unemployment with higher inflation d) Is vertical in the long-run C

According to the Real Business Cycle (RBC) School a positive real shock would

a) Lead to higher real wages, higher employment and higher natural output b) Lead to lower real wages, higher employment and higher output c) Lead to higher real wages, higher employment and higher output d) None of the above A

For Monetarists, New Classical and Real Business Cycle authors

a) Money is neutral in the short run b) Money is neutral in the long run c) Money is not neutral d) None of the above B

Real Business Cycles theory implies that

a) Real wages are pro-cyclical b) Productivity is pro-cyclical c) Output follows a random walk d) All of the above D

Real shocks imply that GDP follows a random walk

a) That means that the natural rate of unemployment is fixed b) That supply shocks must be the dominant force in the explanation of business cycles c) That the natural rate of unemployment is path dependent d) None of the above B

The Rational Expectations Hypothesis (REH) implies

a) That the economy is always at the natural rate of unemployment b) That economic agents have perfect foresight and are always right c) That economic agents use all available information d) None of the above C

According to demand-pull theory of inflation

a) The acceleration of inflation in the 1970s was caused by expansionary fiscal policy b) Is similar to the Quantity Theory of Money c) Stabilization in the 1980s was associated to contractionary monetary policy d) All of the above D

Monetarists, New Classicals and New Keynesians agree that

a) The business cycle is a deviation from the natural output rate b) That the natural rate of unemployment is a strong attractor to the economy c) Demand shocks are central for business cycles d) All of the above A

Monetarists, New Classicals and New Keynesians agree that

a) The business cycle is a deviation from the natural rate X b) That the natural rate of unemployment is a weak attractor to the economy c) Do not agree on anything d) None of the above Although the reasons for the deviations are different, and the policy responses too, they all agree on that, in contrast to Real Business Cycle authors that believe that fluctuations reflect a change of the optimal (natural) level itself.

The financial accelerator implies that

a) The costs of credit intermediation change during the cycle b) When a firm's balance sheets deteriorate, banks demand a higher interest to compensate for risk c) The financial system is pro-cyclical and amplifies the booms and busts, leading to bubbles d) All of the above D

The multiplier-accelerator mechanism implies that

a) The economy fluctuates endogenously around the natural output level b) Technological change is the main cause of the business cycle c) Monetary shocks are irrelevant for the economic cycles d) That capitalist economies are inherently unstable D

If for an expected event aggregate demand increases

a) The economy would move from point 1 to point 4 directly b) The economy would move from point 1 to point 2 and then to point 4 c) The economy would move from point 1 to point 3 and then to point 4 d) None of the above A

. For New Keynesian authors

a) The natural rate of unemployment is variable b) Involuntary unemployment is possible with rational expectations c) Involuntary unemployment is a result of the power of union members d) All of the above X The natural rate varies because of path dependency or hysteresis in New Keynesian models. The New Keynesian models do include rational expectations, and in some models, like the Insider/Outsider, the reason for the variability of the equilibrium unemployment level, and for the existence of involuntary unemployment is related to the bargaining power of union insiders.

The Keynesian Phillips Curve implies that

a) There is a stable tradeoff between inflation and unemployment b) The economy cannot be permanently below the natural rate of unemployment c) That inflation would accelerate with expansionary demand policies d) All of the above A

According to Lucas (New Classical)

a) There is no tradeoff between inflation and unemployment b) The economy moves fast to the natural rate after a shock c) Agents use all available information to make decisions d) All of the above D

Cost-push theories of inflation imply that

a) Wage bargaining and class conflict are central for the acceleration of inflation b) The Vietnam War was a central cause of inflation c) Positive oil shocks explain stabilization in the 1970s d) None of the above A

Mark the flow variable a) savings b) money supply c) wealth d) capital

a) savings Savings is the only flow variable. Is the part not consumed of income, that is a flow.

For Wicksell, the business cycle:

a. All of the other replies b. Resulted from real shocks c. Resulted from deviations of the optimal level d. Resulted from changes to the natural rate of interest A

In the island model if the central bank announces an increase in money supply:

a. Information is costly and output would deviate permanently from the natural level b. Information is freely available and prices would go up c. Information would be costly and output and prices would go up d. Information is freely available and output would deviate permanently from the natural level C

According to Friedman (Monetarist), the Phillips curve:

a. Is vertical in the long-run b. Is vertical in the short-run c. Is horizontal in the long-run d. Is stable and you can only get lower unemployment with higher inflation A

If there is an unexpected increase in aggregate demand, then according to the New Classical model:

a. The economy would move from point 1 to point 2 and then to point 4 b. None of the others c. The economy would move from point 1 to point 3 and then to point 4 d. The economy would move from point 1 to point 4 directly C

neoclassical economics

against government intervention

The Liquidity Trap is a situation in which . Economic agents might expect that the price of bonds will increase b. The LM curve is vertical, and the IS is horizontal c. Economic agents choose to hold bonds in the face of an uncertain future d. Economic agents expect that interest rates will increase

Inflation and the natural rate (freidman)

chap 10 ppt 10 For Friedman the inflation acceleration of the 1970s was evidence of the economy (the actual unemployment rate) being below the natural rate of unemployment. ■ In this case inflation was caused by excess demand, caused both by government excessive spending (fiscal deficits), and by monetary accommodation (expansion) by the Fed. ■ Cost push sources, like the oil price shocks, the wage pressures associated to low unemployment, and the devaluation of the dollar were seen as of secondary importance.

Costless stabilization?

chap 10 ppt 10 Lucas point would imply that a stabilization policy announced by the Fed to control prices and reduce inflation by contracting money supply, and reducing aggregate demand (Yd) if agents are fully informed, should be costless, in terms of output and employment. The Reagan recession caused, to some extent, by Volcker's monetary policy should have been according to Lucas' theory costless. ■ New Classical authors justify the recession to the lack of credibility of the central bank. Sargent's example of a costless stabilization was the German hyperinflation of 1923. In this view, what allowed for stabilization was not the renegotiation of external debt, but the credible monetary reform.

Problems with the natural rate(friedman)

chap 10 ppt 10 Most authors now accept the view that the natural rate of unemployment (or Non Accelerating Inflation Rate of Unemployment, NAIRU) is variable over time. ■Some authors suggest, quite reasonably given how the natural rate is measured (as a moving average), that current unemployment (influenced by fiscal and monetary policies) is the driving force behind the natural rate. ■ Finally, if the natural rate of unemployment is variable and there is a great uncertainty about its actual level, its relevance for policy analysis is greatly diminished.

German hyperinflation

chap 11 ppt 11 External shocks affect the cost structure and may change the income distribution equilibrium of the economy. In the case of Weimar Germany, the need to pay reparations to the Allies was the external shock. ■ The need to pay in foreign currency (dollars) forced Germany to depreciate the mark, in order to export more, import less, and obtain funds to pay for reparations. ■ In the same vein as the increase in agricultural prices, devaluation (depreciation) affects prices directly, and to the extent that imported goods are part of the wage basket, or affect the prices of goods in the wage basket, the real wage will tend to fall. ■ Once again wage resistance will lead to further hikes in prices, and foreign exchange- wage spirals will ensue. Propagation mechanisms will lead to a process of chronic inflation.

Cost-push vs. Demand-pull theories of inflation

chap 1p0 ptt 10 If the system has a tendency to full employment in the long run, as implied by neoclassical economists in all its variations, Neoclassical Synthesis Keynesians, Monetarists, New Classicals, Real Business Cycles authors and New Keynesians, then inflation is, for the most part, seen as a problem of excessive demand. ■ Inflation occurs when the economic system is beyond the natural output level. That is why stagflation, the joint occurrence of stagnation and inflation was such as paradox for conventional theory. ■ Alternative or heterodox views of inflation suggest that inflation could occur below full employment, often associated to changes in the structure of production, distributive conflict and overall cost-push effects.

GNP

chapter 1 the sum of all goods and services produced in a nation in a year -includes income earned abroad for US residents and excluded foreign residents earnings in the US - GDP plus income receipts from the rest of the world minus income payments to the rest of the world is equal to GNP

functional distribution of income

chapter 1 P +WN = GDP

lucas phillips curve

chapter 10 ppt 10 Lucas also assumes that economic know the correct economic model, which is the basic neoclassical model, and that prices adjust fast, or as it is often put markets always clear. ■ The Phillips curve with rational expectations is rewritten as: ■ π = πe - β(u - un) + ε ■ The difference with Friedman's accelerationist version of the PC is that now inflationary expectations are not adaptive, and random shocks play a role in the dynamics of inflation for that reason.

Lucas aggregate supply curve

chapter 10 ppt 10 The aggregate supply curve is written as: - Ys = Yn + α(P - Pe) + ε ■ If the price level exceeds the expected price level, than output would be higher than the level that corresponds to the equilibrium in the labor market, or the natural output level. ■ Firms expanded supply, since they assumed that the higher price represented an increase in the demand for their goods, while in fact it was the money supply that had increased.

FIH cont

chapter 15 ppt 14 As the economy grows, firms and individuals that are on sound financial basis are forced by competition to pursue more risky strategies. If the firm does not follow riskier financial strategies while the competition does, it might loose market share. Hedge financing units are forced into speculative positions, and speculative financing units into Ponzi positions; ■ Financial crises are an endemic problem. Both the Great Depression and the Great Recession can be seen as Minskian processes of financial instability; ■ In the post-Keynesian (Minskian) interpretation of the financial crisis, income inequality also played an important role in the development of the financial bubble. Wage stagnation and income inequality, both in the 1920s and the 1990s and 2000s, led to a substitution of debt for wages. In the absence of higher wages, consumers relied on increased amounts of debt to maintain the consumption patterns.

FIH

chapter 15 ppt 14 ■ Minsky distinguishes between Hedge, Speculative and Ponzi financial structures. In his words: - "Hedge finance takes place when the cash flows from operations are expected to be large enough to meet the payment commitments on debts. Speculative finance takes place when the cash flows from operations are not expected to be large enough to meet payment commitments, even though the present value of expected cash receipts is greater than the present value of payment commitments. Speculating units expect to fulfill obligations by raising funds by new debts... In addition to hedge and speculative finance we can distinguish Ponzi finance—a situation in which cash payments commitments on debt are met by increasing the amount of debt outstanding."

Efficient Market Hypothesis (EMH)

chapter 15 ppt 14 ■ The neoclassical notion that the economic system is self-adjusted with a tendency to full employment, in which money is neutral, is complemented by the idea that financial markets are stable, help facilitate the functioning of the economy, and are not the main source of crises. This view leads to the notion that regulation of financial markets is unnecessary; ■ The EMH suggests that the prices of financial assets reflect all market information, and as a result those prices would not deviate from their fundamentals; ■ The idea is that prices reflect the fundamental values associated to the preferences of agents, the given technology and factor endowments. Prices not only reflect all available information, but they also are the equilibrium prices that clear markets immediately.

Financial Instability Hypothesis (FIH)

chapter 15 ppt 14 Minsky argues that the conventional neoclassical theory that suggests that the financial sector can only disrupt the functioning of an otherwise stable economy is equivalent to a barter economy, while the capitalist economies discussed by Keynes and his followers corresponded to what he refers to as the Wall Street paradigm. In other words, the relevant framework is that of a capitalist economy in which the objective is the accumulation of capital in monetary form; ■ Minsky analyzes the financial structure of corporations and suggests that there is an in built tendency for the financial system to become increasingly fragile and prone to crisis; ■ The central idea in Minsky's FIH is that the normal functioning of the capitalist economy would lead to a financial crisis. In other words, stability is destabilizing.

New Keynesian (NK) views

chapter 15 ppt 14 New Keynesian authors have incorporated some of the ideas of behavioral economics to deal with the possibility of financial crisis; ■ Asymmetric information, the fact that borrowers always have better information about their ability or willingness to repay a loan than creditors, leads to market failures, as banks might not extend loans to creditworthy clients. This sometimes leads to suboptimal results (e.g. adverse selection and moral hazard); ■ NK authors propose the financial accelerator as an explanation for crises. In this view, the costs of credit intermediation change during the cycle. In a recession, when firm's balance sheets deteriorate, banks might demand a higher interest rate to compensate for risk, leading to a reduction in credit when firms need it the most, intensifying the business cycle.

EMH

chapter 15 ppt 14 ■ The microeconomic implication of the EMH is that prices of financial assets would follow a random walk and investors cannot predict values in advance; ■ In a macroeconomic perspective the world of efficient markets is one in which there are no bubbles, since all prices correctly represent the underlying information about the fundamentals; ■ Rational bubbles represent the behavior of agents faced with changes in the fundamentals of the economy. An alternative view, as defended by Eugene Fama, is that there are no bubbles.

Loanable Funds Theory(LFT)

chapter 2 -Neoclassical theory of interest rate -theory of market interest -the interest rate is determined by the demand for and supply of loanable funds -as the interest rate for loanable funds increase it becomes for expensive to borrow and as the interest rate decreases it becomes less expensive to borrow -interest rate for loanable funds will eventually reach equilibrum, where demand = supply -savings available in the economy that can be used to provide loans for investment

Say's Law

chapter 2 pp3 -supply creates its own demand -implied that a general crisis of overproduction could not occur. -the economic system is supply determined -In other words, Savings (S), the part not consumed are identical to Investment (I). -Also, there is no guarantee that the labor force is fully employed by that level of savings. Causality goes from Savings to Investment. Something that Keynes would criticize and reverse with his Principle of Effective Demand.

Gibson Paradox

chapter 2 -Tooke argued that if the central bank increased the interest rate, then the financial costs of firms would go up, and prices would also increase

Real Bills Doctrine

chapter 2 pp3 -that banks created money on the basis of the needs of the real economy Central banks should lend money to commercial banks if and only if the commercial banks use those funds to support "real" (as opposed to speculative) economic activity

marginal productivity of labor (MPN)

chapter 2 workers are paid according to their marginal productivity MPN = W/P Real wage = marginal productivity of labor in assignment 2 question one it wanted the MPN using a dougles function.....ANYTHING WE NEED marginal productivity EX) MPN, MPK take the partial derivative of what you are trying to find.

Quantitative Theory of Money

chapter 2 and chapter 3 -The quantity theory of money is a theory that variations in price relate to variations in the money supply. The equation says that the nominal value of output equals the amount of money necessary to make output circulate. It is essentially an identity MV=Py where M is money, V is velocity of money, P is the price level, and y stand for the real output, that is GDP (Y) divided by the price level. If the amount of money in circulation is relatively small for the flow of goods and services produced, the velocity would be very high, and vice versa for a situation with a large amount of money M=L=kPy cambrige version of QTM

Kaleckian version of the multiplier

chapter 5 W+R=Y=C+I C=wY Y= 1/(1-w) In this very simplified model then wages are all consumed (W=C) and profits are all saved (R=S).

Savings Function or equation

chapter 5 PPT 5 If we assume a closed economy without government, for simplicity, total output (value-added) is equal to demand, which would be composed of consumption (C) and investment (I) demand, which is also equal to income (Y). C+S=Y=C+I Keynes suggests that it is the autonomous decision to spend, investment, that determines the level of income, savings.

Multplier

chapter 5 ppt 5 Keynesian Y=Ca + cY Where c is the propensity to consume out of income -ANother way to express Y = Ca+I/(1-c) Remember to relate it back to consumption saving etc. we will need to use C+S=Y=C+I For example what we did in the class disscussion question 1. used Y = Ca+I/(1-c) then needed C+S=Y=C+I to relate back to savings and consumtion

UNEMPLOYMENT EQUILIBRIUM

chapter 5, PPT 5 IN SIMPLE TERMS WHEN THE UNEMPLOYMENT IS HIGHER THAN USUAL -Keynes main objective was to show that the economy would not have a tendency to full employment, as implied in the neoclassical model, and that involuntary unemployment was the norm of the functioning of advanced monetary economies; Keynes wanted to show that unemployment equilibrium was possible, something that would be by definition a contradiction in terms in the neoclassical model, since unemployment, other than frictional and voluntary, was not possible in equilibrium; -importance of general theory is explanation of why the economic system might not have in the long run a tendency to full employment.

Keynesian investment and savings

chapter 5, ppt 5 also have this in study guide graph notes The Keynesian system implies that the equality between investment (I) and savings (S) is accomplished by changes in the level of income (Y) INVESTMENT IS AUTONOMOUS DEMAND AND DETERMINES INCOME. As income increases a share of it is saved, and the multiplier mechanism guarantees that the increase in income is sufficient to make savings equal to the original investment;

Shocks to the ISLM curve and it effects And fiscal and monetary polics

chapter 6 PPT 7 Aggregate demand shocks would affect the equilibrium in the goods and services as well as in the money market; GO TO STUDY GUIDE GRAPHS NOTES

keynesian investment and savings part 2

IS curve

chapter 6 ppt 6 IS - Investment and savings Equality between savings and intestment formula S+(T-G)+(Z-X)=I Spending demand and income The basic macroeconomic identity for a closed economy with government is: C+S+T=Y=C+I+G The IS curve is derived from the tree previous equations, with G being autonomous, that is, independent of income: Y=A-fr/(1-c(1-t) A=Ca+Ia+G The IS curve can be defined simply as a locus of various combinations of interest rates and income, which guarantees equilibrium between saving and investment

IS curve slope

chapter 6 ppt 6 The IS curve would be flatter (steeper) if investment is more (less) sensitive to the rate of interest. A reduction of the rate of interest would lead to a big (small) increase in investment, and, hence, in income; The IS would be flat (steep) if the multiplier is relative large (small), since even for a minor reduction in the interest rate and a small change in investment a big (small) increase in income would follow.

ISLM model

chapter 6 ppt 6 The ISLM model represents the simultaneous or general equilibrium in the goods and money markets, and is designated by the equilibrium of supply and demand in both markets. The equilibrium in the goods market, based on the multiplier and the PED implies that investment equals savings, and that has been called the IS curve. The money market is represented by the equilibrium of money supply and demand, or the demand for liquidity, and the resulting equilibrium is the LM curve. IMPORTANT The intersection of the IS and LM curves allows us to find the equilibrium values of output and the rate of interest, and the simultaneous equilibrium in the goods and services and money markets.

LM curve

chapter 6 ppt 6 The LM curve represents the equilibrium in the money market, between the demand for money or liquidity and supply of money. The LM provides the various combinations of interest rates and income, which guarantee equilibrium in the money market. We can also derive the LM curve algebraically from a very simple behavioral equation. Money demand can be represented as follows LM DETERMINES THE RATE OF INTEREST L=P(kY-hr) M=L or M/p = L also: r=1/h(kY-M/P)

Income distribution effect

chapter 7 ppt 8 Keynes noted also that deflation might affect income distribution, and through that channel affect the size of the multiplier and of the level of income of equilibrium. Keynes suggested that a deflationary crisis would lead to fall in wages greater than in prices and redistribution from wage earners to capitalists; Keynes believed that entrepreneurs would suffer more than rentiers, those that lived from the remuneration of financial assets, since the later would have a certain nominal gain guaranteed; ■ Keynes argued that rentiers would have a lower propensity to consume than entrepreneurs, and the latter would have a lower propensity to consume than workers, and, hence, redistribution would reduce the multiplier effect, and lead to a lower level of income.

Keynes effect

chapter 7 ppt 8 Keynes argued that neoclassical economists were correct in assuming that price flexibility might lead the system back to full employment. He suggested that the main mechanism by which lower prices would lead to full employment would be thorough its effect on the interest rate; Keynes argued that neoclassical economists were correct in assuming that price flexibility might lead the system back to full employment. He suggested that the main mechanism by which lower prices would lead to full employment would be thorough its effect on the interest rate; P ↓⟹ M/P ↑⟹ r↓⟹ I↑⟹ Y↑

ISLM and aggerate demand

chatper 7 The aggregate demand curve can also be derived analytically, given the equilibrium between the IS and the LM. Both curves are given by respectively: Y= A-fr/(1-c(1-t)) and r=1/h(kY-M/P) subsisting we have Y= A + fM/hP/((1-c(1-t)+fk/h)

If the economy is described by the following functions C = 375 + 0.75 (Y - T) I = 100 G = 100 T = 100 What is the value of GDP and the fiscal deficit if G increases to 200 Select one: a. 2,400 and 100 b. 2,400 and 0 c. 2000 and 200 d. 2,000 and 0

If the share of wages in total income is 0.75, what would be the size of the multiplier in the simple Kaleckian model when capitalist save all their income, and workers consume all of their income Select one: a. 0.25 b. 2 c. 3 d. 4

Difference between endogenous variable and exogenous variable

endogenous variable is one that is explained by the economic model, while the exogenous variable is determined outside the model.

Flow variable vs Stock variable

flow variable: a variable with a time dimension stock variable: a variable without a time dimension GDP is a flow variable because it has a time dimension

efficiency wage

graph ppt 13 chapter 13

natural rate of interest

is the level of interest that equilibrates savings an investment, but also corresponds to a situation of full employment in the labor marker, and with the economy at its natural or optimal level of output.

Finding Equilibrium

just set them to eachother and solve for example) 2x+4=Y and 4x+3=Y

Just a note

keynesian chapters 5-7 and neoclassical 1-4 it would be easier to find stuff this way.

IF it asks for a question to find the multiper look at the quiz

know t

not given yet

Mark the flow variable a) savings b) money supply c) wealth d) capital

not given yet

principle of effective demand

opposite of says law investment determines savings

From PC to supply curve

pi = pi^e-B(u-un) (Y-Yn)=-a(u-un) Y=Yn+Y(P-P^e)

Assume an accelerationist (or Monetarist) version of the Phillips written as follows: 𝜋𝑡 = 𝜋𝑡 𝑒 − 𝛽(𝑢𝑡 − 𝑢𝑛) If inflation expectations are adaptive, and previous inflation was 2%, the current level of unemployment is 3.8% and the natural rate of unemployment is 4.2%, then what would be the inflation level in three periods, if monetary and fiscal policies do not stimulate the economy further? Assume is equal to 1.

pi t = .02 - ( .038 - .042) = .024 pi t+1 = .024 - (.038 - .042) = .028 pi t+2 = .028 - (.038 - .042) = .032 Inflation accelerates 3.2%

IS equation

powerpoint 6 C+S+T=Y = C+I+G For IS curve always solve for Y

LM equation

powerpoint 6 m/p = L For LM curve always solve for R

supply side(labor market)

pp3 -Labor demand reflects profit maximization of the firms (MPN=W/P) -unemployment frictional -maximization of workers The Production Function implies that the optimal level of output corresponds to the equilibrium in the labor market;

Demand side(Money market)

pp3 The effect of expanding money supply, to boost demand, for a given optimal (natural) output level and a constant velocity of circulation is to increase prices (inflation). The demand side in the neoclassical model comes from the Quantity Theory of Money; MV=PY Or alternatively in the Cambridge version: ■ M=Md=kPY ■ Where k=1/V this equation is used in assignment 2 question 2.....look for them asking "Output being optimal" and (natural neoclassical theory)

The Policy Ineffectiveness Proposition

ppt 10 chapter 10 As the Fed expands aggregate demand, agents with perfect information would react and lead to a contraction of the aggregate supply curve, that is supply the same amount at higher prices, with no effect on the level of activity, moving directly from point A to point B.

Lucas and Rational Expectations continued

ppt 10 chapter 10 Rational expectations mean that agents form expectations on the basis of the statistical expected values, meaning the longrun average value of repetitions of the expected event. ■ Mistakes can happen, but they are random, and do not have a particular pattern. ■ The expectation of inflation is: ■ πe=E(π)+ ε ■ The ε is a random error term. In other words, agents can make mistakes, but not systematic errors.

Friedman and the Phillips Curve (PC)

ppt 10 chapter 10 The incorrect idea that the Fed could manage the trade off between inflation and unemployment is what leads to excessive monetary expansion, and to inflationary pressures. The myth of the PC. ■ Friedman argued that the Fed cannot affect unemployment in the long run, and it should follow a simple monetary growth rule. ■ Friedman was against targeting the interest rate, since he believed that it would made monetary aggregates unstable. ■ The Phillips curve with adaptive expectations is rewritten as: ■ π = π-1 - β(u - un)

Alternative explanation for Great Inflation

ppt 11 chap 11 An alternative explanation for the inflationary pressures of the 1960s is possible. The Golden Age accumulation regime implied a commitment to full employment and the creation of a safety net for unemployed workers. Full employment tended to increase the bargaining power of the working class; ■ Inflation was the result of wage pressures - cost-push - rather than the expansionary fiscal and monetary policies - demand-pull; ■ More specifically, the inflationary process of the late 1960s and 1970s seems to be related to the increases in taxes (passed to prices), competitive depreciations, more prominently after 1973, and supply side oil shocks (1973 and 1979(, and to wage resistance by relatively string unions.

Monetary misperception cycles

ppt 11 chap 11 The Monetarist and New Classical arguments suggest that business cycles are caused by monetary shocks caused by the Fed. ■ Cycles are temporary deviations from the optimal natural rate of unemployment level, and the self-adjusting mechanisms of the economy would bring it back to the natural rate. ■ The concept of the natural rate of unemployment, developed by Friedman, is what underpins these views of the cycle. The limitations of the concept reflect on these theories of the business cycle. The crucial feature of New Classical models, however, is not so much that it concentrates in the rational behavior of individual agents. ■ Rational agents expect and behave in accordance with what the model requires them to anticipate. It is the model, which embraces Friedman's natural rate of unemployment that guides the final results. ■ In that sense, Lucas complements the Monetarist counterrevolution, while taking more extreme policy conclusions

The Great Inflation of the 1970s

ppt 11 chapter 11 The 1970s stagflation episode, often referred to as the Great Inflation, to contrast it and compare it to the 1930s Great Depression, is often seen as partially explaining the demise of Keynesian economics.\ ■ Conventional wisdom presumes that the inflationary pressures were brought about by the expansionary fiscal policies in the United States, and the propagation of these inflationary pressures through the international system. ■ The increasingly expansionary fiscal policies of the 1960s led to growing balance of payments deficits. The accumulation of idle dollar balances started to put pressure on the money supply of the rest of world, leading to inflation. ■ According to the Monetarist logic, inflation was caused by the United States fiscal and monetary policies, and transmitted to the world as a result of the system of fixed parities.

Heterodox models of inflation

ppt 11 chapter 11 ■ Inflation is the result of three factors: - Inertia associated to indexed contracts (particularly wages). - Changes in relative prices (agricultural goods, imported inputs). - Changes in wages above indexation, and changes in mark-ups that reflect distributive conflict. ■ Inertia is essential in the explanation of persistently high inflation that never leads to full-fledged hyperinflation. This was typical of the Latin American inflationary experience. ■ The other two factors are normally more important. For Structuralist authors' inflation is an inevitable companion of the process of development. Industrialization implies profound changes in the structure of production, reducing the size of the agricultural sector, increasing the demand for imported intermediary and capital goods. ■ The process of development, thus, increases the possible sources of supply-side constraints on the economy. The increase in manufacturing production may come at the expense of the agricultural sector's ability to produce foodstuffs for domestic consumption. ■ The relative scarcity of agricultural goods would lead to higher prices. More importantly, by increasing the price of foodstuffs, industrialization may lead to a reduction of the real wage. ■ Real wage resistance would then lead to wage-price spirals that propagate through the indexation mechanism.

Rational Expectations and Real Business Cycle (RBC) School

ppt 12 and chap 12 RBC developed as a follow up to the New Classical School of Lucas; ■ Rational Expectations (RE) implies that agents use all the available information: - (i) all data (past and present) that is cost effective to obtain and publicly known that might affect the variable on which expectations are being formed; - (ii) the economic model and how different variables interact. ■ According to RE policy makers cannot affect economic outcomes in a persistent way. Policy is inefficient. But markets are in disequilibrium when unexpected events take place; ■ RBC authors suggest that shocks lead to the change of the optimal equilibrium of the economy, reflecting the rational economic agents decisions. The economic fluctuations are optimal and represent at all time the decisions of agents and are to be seen as optimal. Hence, the name equilibrium business cycles.

RBC

ppt 12 chap 12 Kydland and Prescott (1982) provided a purely supply-side explanation of the business cycles, which harks back to Wicksell's notion of real shocks and to Joseph Schumpeter's views on economic fluctuations; ■ Central for the RBC argument was the evidence presented Nelson and Plosser (1982) according to which output follows a random walk, and after a shock output does not revert to its original trend. This suggests that the GDP trend is path dependent and presents hysteresis, meaning that current output depends on past output and that history matters; ■ This random walk process implies that any random change in productivity will have permanent effects on productivity and, as a result, on aggregate output. Once shocked the system does not return to the mean; ■ The Business cycle is not a temporary deviation from the natural rate. It is a change in the natural rate itself.

Real wages & Money

ppt 12 chap 12 Real wages have been only slightly procyclical during the postwar era and basically acyclical over the entire period. A large number of other studies have basically supported the conclusion that over long periods of time real wages are mildly procyclical to acyclical within the United States; ■ These results raise red flags because RBC models need large procyclical changes in the real wage during business cycles in order to generate large changes in voluntary unemployment; ■ The 1981-1982 recession was clearly caused by a large contraction in money growth and higher interest rates initiated by the Fed to reduce inflation.

Measurement problems

ppt 12 chap 12 Solow Residual or Total Factor Productivity (TFP) ■ Production function: - ! = #(%&'()&) - *+ *, = *- *, − / *0 *, − 1 − / *2 *, ■ Problem, we know that by definition: - ! = 3' + 5% ■ Hence, the income identity suggests that growth of income corresponds to the growth of capital, weighted by their share in output, and by the weighted growth of wages and profits. TFP must represent the latter. R

RBC & Unemployment

ppt 12 chap 12 Unemployment is also efficient in RBC models because it is completely voluntary. Involuntary unemployment is not possible because labor markets are perfectly competitive; ■ RBC models argue that money is neutral and never has real effects on the economy; ■ RBC economists believe that lower taxes stimulate output by increasing aggregate supply, not like Keynesians that suggest that lower taxes stimulate demand;

Causes of productivity shocks

ppt 12 chap 12 ■ Changes in technology; ■ Changes in the price of important inputs into production, such as the price of oil; ■ Changes in government taxation and regulation; ■ Wars and natural disasters; ■ Demographic factors.

Demand shocks and Price rigidities

ppt 13 chapter 13

Keynesians?

ppt 13 chapter 13 New Keynesians do NOT represent a full break with Monetarism, Rational Expectations and RBC authors; ■ New Keynesian models borrow the concepts of market failure and price inflexibility from Keynesian economics, the natural rate hypothesis and a focus on monetary policy from Monetarist economics, the concept of rational expectations from the Rational Expectations model, and a belief in the importance of developing models with microeconomic foundations from Real Business Cycle models.

Anomalies

ppt 13 chapter 13 The stagflation of the 1970s was clearly not caused by monetary policy, so the belief that changes in the money supply were the sole source of all business cycles seemed increasingly difficult to support; ■ The close relationships between the monetary base, the money supply, and output broke down during the 1980s; ■ By the 1990s the very idea of a natural rate of unemployment became more doubtful after unemployment fell below 6% (the supposed natural rate), but no inflationary acceleration followed.

Business Cycle

ppt 13 chapter 13 ■ Aggregate demand could fall because of a change in expectations or risk perceptions that reduces investment and consumption demand, similar to that argued by old Keynesians; ■ Aggregate demand could also fall because of a contraction in the money supply, which reduces the supply of credit and investment, as argued by the Monetarists; ■ Finally, and original to New Keynesian models, an increase in the default risk perceptions could reduce supply of credit, leading to falls in consumption and investment ■ Aggregate demand could fall because of a change in expectations or risk perceptions that reduces investment and consumption demand, similar to that argued by old Keynesians; ■ Aggregate demand could also fall because of a contraction in the money supply, which reduces the supply of credit and investment, as argued by the Monetarists; ■ Finally, and original to New Keynesian models, an increase in the default risk perceptions could reduce supply of credit, leading to falls in consumption and investment

Market imperfections

ppt 13 chapter 13 ■ The fundamental New Keynesian explanation for business cycles are associated to shocks in an economy with price and wage rigidities, that lead to temporary disequilibrium; ■ The main models of price and wage rigidity are: menu costs, insider-outsider workers, staggered contracts, implicit contracts, efficiency wages, etc.

Treasury view

ppt 3 Below is answer to quiz The "Treasury View" suggests that if government spending increases above the tax level (I+G-T) then there will be less resources for private spending and public spending will crowding out private spending.

Loanable Funds Theory(capital market)

ppt 3 The rate of interest in neoclassical economics is derived in the capital market and is analogous to the labor (other factor of production) market story; ■ Diminishing returns imply that the MPK is negative sloped, and represents the firm demand for capital goods; ■ The supply of funds for investment depends on the consumers maximization of utility, with patience (less consumption now) being rewarded with higher consumption in the future;

Tendency to full employment and countervailing forces

ppt 8 chapter 7 Keynes suggested that it was possible for the economic system to move back to full employment with price flexibility, and he provided a mechanism by which that might take place, the so-called Keynes effect; Keynes believed that for at least two important reasons, related to the role of debt and income distribution on spending, it would be unlikely that full employment would be the outcome of price and wage flexibility. As he famously argued, price and wage flexibility might make things worse.

The natural rate (keynesian)

ppt 9 and chapter 9 The Keynesian rationalization for the Phillips curve (PC) suggests that the rate of change in money wages is a function of excess demand in the labor market and the PC can be written as (1.) ! = −"# ■ Yet the experience of the 1960s, in which macroeconomic policies were used to stabilize the business cycle, brought serious doubts about the stability of the Phillips relation. ■ Friedman anticipated the breakdown of the Phillips curve, suggesting that the relation had only short-term validity, and that in the long run there is no tradeoff between inflation and unemployment. ■ Friedman argued that inflationary expectations were relevant for wage bargaining. Hence the original Phillips equation had to be augmented to incorporate expectations. For Friedman, the only way government can maintain a level of unemployment below its natural level is by accelerating inflation. ■ In terms of the Phillips Curve what Friedman suggested is that the actual behavior of prices would depend not only on actual unemployment, but also on the discrepancy between actual and natural unemployment, the so-called unemployment gap. The Monetarist PC would be given by: pi = pi-1-B(U-Un) **see graph in notebook

The short run aggregate supply

ppt 9 chapter 9 If prices increase and the nominal wage remains constant, then the real wage would fall, and accepting the neoclassical downward sloping labor demand curve, as Keynes did in the GT, would lead to an increase in employment, and hence output. The short run aggregate supply (Ys) was derived from the rigidity of prices. With higher prices for their products and lower costs of production, that is, lower real wages, firms would produce more. ■ An expansion of demand would lead to higher output, but also to somewhat higher prices. In this case, if a tax cut, like the Kennedy-Johnson one, would lead to higher consumption, a movement of the IS curve to the right and a concomitant expansion of aggregate demand (Yd), then the effect with nominal wage rigidity would be a higher level of output and an increase in the price level. The Keynesian advisors to Kennedy assumed that unemployment could be reduced and this would lead to a slightly higher level of inflation, which would be, however, stable. see notebook for graph

Neoclassical Synthesis

ppt 9 chapter 9 The Keynesian Revolution succeeded in showing that, even with price flexibility, the economic system did not have a tendency to full employment. ■ In spite of its theoretical triumph, Keynesian economics came to be eclipsed, early on, by a more subdued and less revolutionary interpretation about the functioning of the economy. ■ In this view, dubbed the Neoclassical Synthesis by Paul Samuelson, Keynesian economics was simply related to the notion that, with price and wage rigidity, which seemed to be reasonably frequent empirical occurrence, unemployment was possible. ■ Keynes system was reduced to a situation of disequilibrium, resulting from an imperfection of the economic system. Cont. ■ The Neoclassical Synthesis built on the ISLM model developed by Hicks, and accepted that the Real Balance Effects would restore full employment equilibrium in long run. ■ Franco Modigliani, a Nobel winner, and other neoclassical Keynesians emphasized the role of nominal wage rigidities in explaining unemployment. ■ This complacent reassertion of the self-adjusting nature of the economic system was seen as reasonable since in the 1950s the economy seemed to be stable and close enough to full employment. Neoclassical Synthesis

Monastery Philips curve

ppt 9 chapter 9 pi = pi-1-B(u-un) Friedman anticipated the breakdown of the Phillips curve, suggesting that the relation had only short-term validity, and that in the long run there is no tradeoff between inflation and unemployment. ■ Friedman argued that inflationary expectations were relevant for wage bargaining. Hence the original Phillips equation had to be augmented to incorporate expectations. Cont. ■ For Friedman, the only way government can maintain a level of unemployment below its natural level is by accelerating inflation. ■ In terms of the Phillips Curve what Friedman suggested is that the actual behavior of prices would depend not only on actual unemployment, but also on the discrepancy between actual and natural unemployment, the so-called unemployment gap. The Monetarist PC would be given

(Keynesian) Phillips Curve

ppt 9 chapter 9 respresented as pi=-BU A Keynesian Phillips Curve Tradeoff between Unemployment and Inflation. A Phillips curve illustrates a tradeoff between the unemployment rate and the inflation rate; if one is higher, the other must be lower. For example, point A illustrates an inflation rate of 5% and an unemployment rate of 4

measure of GDP

refer to chapter 1 - measure of real output (flow variable) - 3 measurements of GDP 1) Added value 2)Income 3) Demand C+S+T=Y=C+I+G+(X-Z) consumption = C investments = I government consumption and Investment = G foreign demand for domestic goods or exports = X domestic demand for foreign goods or imports = Z savings = S taxes = T income = Y

The defenders of the Treasury View argued

that fiscal deficits crowd out private investment

For neoclassical authors macroeconomics is

the aggregation of the behavior of rational economic agents

differences between neoclassical and keynes models

the main differences between neoclassical and structural-Keynesian models are related to their assumptions, that is, what they decide to include and exclude from their models

production function

the relationship between quantity of inputs used to make a good and the quantity of output of that good -states the amount of product that can be obtained from every combination of factors, assuming that the most efficient available methods of production are used. Y= f(K,L) Y = K^1/2L^1/2 Total output of GDP = Y Labor= N(variable) Capital = K(fixed)

labor market equilibrium

the situation in which the quantity of labor supplied equals the quantity of labor demanded In the GT Keynes shows that the conventional story of the labor market is fraught with problems. Keynes concentrated on the problems with the labor supply curve (Ns), but as we will see later the labor demand curve (Nd) is also problematic. In essence Keynes' point is that the determination of the level of employment does not take place in the labor market; in Keynesian model unemployment is result of lack of demand

keynes 3 reasons why we would hold money

the transactions motive, the speculative motive, and the precautionary motive.

GDP can be seen measured in three different ways, namely

value added, demand, and income

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