Chapter 11 - Classical and Keynesian Macro Analyses

Say's law

A dictum of economist J. B. Say that supply creates its own demand. Producing goods and services generates the means and the willingness to purchase other goods and services.

New growth theory

A model of​ long-run economic growth which emphasizes that technological change is influenced by economic incentives and so is determined by the working of the market system. It suggests that the accumulation of knowledge capital is a key determinant of economic growth.

Economic growth model

A model that explains growth rates in real GDP per capita over the long run. Since the average person can buy more goods and services only if the average worker produces more goods and​ services, the economic growth model focuses on the​ long-run increases in labor productivity.

Which of the following will occur when aggregate supply remains stable but aggregate demand falls in the short​ run? A. The unemployment rate falls. B. The price level rises. C. A recessionary gap is created. D. An inflationary gap is created.

A recessionary gap is created.

New growth theory suggests that the accumulation of knowledge capital can be slowed because knowledge is both nonrival and nonexcludable. How does the federal government intervene in the market to increase the amount of knowledge​ capital?

A. Subsidies B. Patents C. Public education D. All of the above

in considering the forces which may increase an​ economy's real GDP in the long​ run, which of the following will NOT play a​ role?

Lower wages for labor.

Along the​ per-worker production​ function, what happens to real GDP per hour worked as capital per hour worked​ increases?

Real GDP per hour worked increases at a decreasing rate.

Inflationary gap

The gap that exists whenever equilibrium real GDP per year is greater than full-employment real GDP, as shown by the position of the long-run aggregate supply curve

recessionary gap

The gap that exists whenever equilibrium real GDP per year is less than full-employment real GDP as shown by the position of the long-run aggregate supply curve.

Recessionary​ gap:

The gap that exists whenever equilibrium real GDP per year is less than​ full-employment real GDP as shown by the position of the​ long-run aggregate supply curve.

Which of the following is a true statement regarding the economic growth​ model's predictions and how it actually affects the real​ world?

The growth model predicts that poor countries should catch up with rich​ countries, but developing countries are not catching up to lower−income industrialized countries as a group.

"The most outstanding characteristic of Soviet growth strategy is its consistent policy of very high rates of​ investment, leading to a rapid growth rate of​ [the] capital​ stock." This turned out to be a very poor growth strategy because

there were diminishing returns to capital.

What term describes the relationship between real GDP per hour worked and capital per hour​ worked, holding the level of technology​ constant?

the​ per-worker production function

The figure in the window on the right shows average annual growth rates in real GDP per hour worked in the United States. Based on the data from the figure on the right which one of the following statements is​ false?

The growth rate of real GDP per hour worked has not continually accelerated over time. Growth in the first half of the twentieth century was faster than growth during the nineteenth​ century, and growth from 1950 to 1973 was faster yet. Then the unexpected​ happened: For more than 20​ years, from 1974 to​ 1995, the growth rate of real GDP per hour worked slowed. The growth rate during these years was more than one percentage point per year lower than during the​ 1950-1973 period.

Keynesian short-run aggregate supply curve

The horizontal portion of the aggregate supply curve in which there is excessive unemployment and unused capacity in the economy

The​ short-run Keynesian aggregate supply curve is

The horizontal portion of the aggregate supply curve in which there is excessive unemployment and unused capacity in the economy.

The average annual growth rate is the rate at which GDP must grow on an average each year between 2005 and​ 2015,

and the total percentage increase in real GDP is the percentage increase in real GDP between the two years 2005 and 2015.

When savings is​ high

banks have more money to loan. This allows firms to borrow money for investment projects like new factories or better technology. In​ low-income countries, the level of​ saving, and therefore the level of borrowing for new​ technology, is very low. If governments increase the incentives for saving​ money, then firms will have better access to loanable funds and will be better able to acquire​ new, more productive technology. Deferred tax retirement accounts for individuals and investment tax credits are examples of such incentives.

Some economies are able to maintain high growth rates despite diminishing returns to capital by using

better or enhanced​ technology, along with accumulating​ capital; these economies are growing because​ technology, unlike​ capital, is subject to increasing returns.

Both Lowell and Andover use compounding to calculate their interest calculation and they both have the same average​ rate,

but​ algebraically, even a modest percentage increase in the interest rate compounded over time can increase earnings substantially.

Suppose that there is a​ temporary, but significant increase in oil prices in an economy with an​ upward-sloping SRAS curve. As a policy response to this​ short-lived but sudden increase in oil​ prices, a central bank

cannot stabilize both the price level and the real GDP simultaneously.

If the central bank wishes to prevent the equilibrium price level from changing in response to the oil price​ increase, it should

decrease the quantity of money in circulation in order to shift aggregate demand leftward. because By decreasing the quantity of money in​ circulation, the central bank will ideally push the AD curve leftward so that the price level remains at its original level. The economy moves from point A to point B.

​Cost-push inflation is caused by persistent

decreases in​ short-run aggregate supply.

Firms in this nation do not import raw materials and other productive inputs from​ abroad, but foreign residents purchase many of the​ nation's goods and services. the ​short-run effect upon the economy is

deflation and a lower real GDP.

Inflation that is caused by excess consumer demand is known​ as:

demand-pull inflation.

Consider the per-worker production function to the right. Equal increases in the quantity of capital per hour worked lead to ______ increases in output per hour worked.

diminishing

When additions of input to a fixed quantity of another input lead to progressively smaller increases in​ output, we say we are facing

diminishing returns

A sustained increase in the general level of prices is defined​ as:

inflation

Government policy can increase the accumulation of knowledge capital in all the following ways except​ by:

investing in capital accumulation.

The model of​ long-run equilibrium

is the same as the classical model Explanation The model of​ long-run equilibrium is the same as the Classical Model. They are based on identical assumptions and both conclude that the economy will be in full employment.

At the​ macro-economy level,

knowledge capital exhibits increasing returns and physical capital exhibits decreasing returns.

Firms are likely to underinvest in research and​ development, which slows the accumulation of knowledge​ capital, slowing economic​ growth, because

knowledge capital is both nonrival and​ nonexcludable; other firms can freely access the research and development of one particular firm.

The lower the rate of​ interest, the​ ________ profitable it is to invest and the​ ________ the level of desired investment.

more; higher

If an excess quantity of labor is supplied at a particular wage​ level, the wage level

must be above equilibrium

The​ analyst's reference to the​ "process of​ urbanization" describes the

process of people moving from rural areas to cities.

Technological change shifts

up the​ per-worker production function and allows the economy to produce more real GDP per hour worked with the same quantity of capital per hour worked. Because of diminishing returns to​ capital, continuing increases in real GDP can only be sustained if there is technological change.

According to modern Keynesian​ analysis, the​ short-run aggregate supply curve is

upward sloping.

measures of the standard of living​ include:

-Life expectancy at birth -Infant mortality​ (per 1,000 live​ births) -Percentage of the population surviving on less than​ $2 per day -Percentage of the population with access to improved water source -Percentage of the population with access to improved sanitation -Internet users per​ 1,000 people

changes that cause a Decrease in Aggregate supply

1. Depletion of raw materials 2. Decreased competition 3. An increase in international trade barriers 4. More regulatory impediments to business 5. A decrease in labor supplied 6. Decreased training and education 7. An increase in marginal tax rates 8. An increase in input prices

changes that cause an increase in Aggregate supply

1. Discoveries of new raw materials 2. Increased competition 3. A reduction in international trade barriers 4. Fewer regulatory impediments to business 5. An increase in the supply of labor 6. Increased training and education 7. A decrease in marginal tax rates 8. A reduction in input prices

economists agree on four key​ points:

1. Failure to enforce the rule of law. If property rights and contracts are protected in a​ well-functioning legal​ system, production of goods and services occurs more quickly. Many low income countries have compensated legal systems​ and, as a​ result, property rights and contractual obligations are not​ well-protected. 2. Wars and revolutions. Extended periods of war or violent changes in government prevent optimistic investment in an economy. We have​ seen, however, marked economic growth in countries shortly after​ long, costly wars. 3. Poor public education and health. People who are sick or are less educated tend to be less productive members of the workforce. 4. Low savings rates and investment. Low savings rates in​ low-income countries contribute to a vicious cycle of poverty.​ Low-income households save less. When households save​ less, less is available for firms to borrow. Without the ability to​ borrow, firms do not acquire new production technologies and economic growth stagnates.

Explaining The Short-run aggregate Supply curve's upward Slope In the modern Keynesian short run, when the price level rises partially, real GDP can be expanded beyond the level consistent with its long-run growth path, discussed in Chapter 10, for a variety of reasons:

1. In the short run, most labor contracts implicitly or explicitly call for flexibility in hours of work at the given wage rate. Therefore, firms can use existing workers more intensively: They can get workers to work harder, to work more hours per day, and to work more days per week. 2. Existing capital equipment can be used more intensively. Machines can be worked more hours per day. Some can be made to operate faster. Maintenance can be delayed. 3. Finally, if wage rates are held constant, a higher price level leads to increased profits from additional production, which induces firms to hire more workers. The duration of unemployment falls, and thus the unemployment rate falls. Furthermore, people who were previously not in the labor force (homemakers and younger or older workers) can be induced to enter it. All these adjustments cause real GDP to rise as the price level increases.

Government policy can help increase the accumulation of knowledge capital in three​ ways:

1. Patents and copyrights protect the owner from competition. 2. Research and development subsidies increase the amount of these activities. 3. Education subsidies allow free education from kindergarten through 12th grade.

The classical model makes four major assumptions:

1. Pure competition exists. No single buyer or seller of a commodity or an input can affect its price. 2. Wages and prices are flexible. The assumption of pure competition leads to the notion that prices, wages, and interest rates are free to move to whatever level supply and demand dictate (as the economy adjusts). Although no individual buyer can set a price, the community of buyers or sellers can cause prices to rise or to fall to an equilibrium level. 3. People are motivated by self-interest. Businesses want to maximize their profits, and households want to maximize their economic well-being. 4. People cannot be fooled by money illusion. Buyers and sellers react to changes in relative prices. That is to say, they do not suffer from money illusion,

Technological change

A change in the quantity of output a firm can produce using a given quantity of inputs. Technological change has three main​ sources: 1. Better machinery and​ equipment, such as improvements in computer operating systems. 2. Increases in human​ capital, such as worker skill sets and education levels. 3. Better means of organizing and managing​ production, such as ​just-in-time production. Try Again

Why do economic growth rates​ matter?

A. High levels of sustained economic growth reduce infant mortality. B. High growth rates coincide with improved living standards. C. When a country sustains high growth​ rates, life expectancy at birth increases. D. All of the above.

The figure to the right illustrates the relationship between weak and strong rule-of-law countries and economic growth. In addition to a​ country's failure to enforce​ rule-of-law, what else explains why more​ low-income countries do NOT experience rapid growth as the​ catch-up line​ predicts?

A. Shortage of childhood vaccinations B. Lengthy civil wars C. Inability to borrow money needed for investment D. All of the above

The extent to which real GDP responds to changes in the price level along the​ short-run aggregate supply curve is largely determined by

A. the speed with which input prices adjust and people become more fully informed. B. the ability of firms to hire additional​ inputs, particularly workers. C. the ability of firms to use existing workers and capital more intensively. D. All of the above.

Most workers in this​ nation's economy are union​ members, and unions have successfully negotiated large wage boosts. At the same​ time, economic conditions suddenly worsen ​abroad, reducing real GDP and disposable income in other nations of the world.

AD decreases and SRAS decreases

Suppose that businesses in this nation initially had been exporting significant amounts of domestically produced goods and services abroad. Assume that other nations of the world have experienced a sudden decline in economic conditions. What happens to the​ nation's aggregate demand​ curve? In the short​ run, will the nation experience an inflationary gap or a recessionary​ gap? Explain. In the short​ run, the equilibrium price level will ____ and the nation will experience a _____ gap because the​ short-run equilibrium level of real GDP per year is _____ real GDP at full employment.

AD decreases, equilibrium price decreases fall; recessionary; less than

A major hurricane has caused short minus term halts in production at many firms and created major bottlenecks in the distribution of goods and services that had been produced prior to the storm. At the same​ time, the​ nation's central bank has significantly pushed up the rate of growth of the​ nation's money supply.

AD increases and SRAS decreases

A weakening of the value of this​ nation's currency in terms of other​ countries' currencies affects both the SRAS curve and the AD curve.

AD increases and SRAS decreases

Which of the following will occur when aggregate supply remains stable but aggregate demand increases in the short​ run? A. The unemployment rate rises. B. A recessionary gap is created. C. The price level falls. D. An inflationary gap is created.

An inflationary gap is created.

The economic growth model explains growth in real GDP per capita in the long run. Because of the importance of labor productivity in explaining economic​ growth, the economic growth model focuses on the causes of increases in​ long-run labor productivity. What are the key factors that determine labor​ productivity?

C. Quantity of capital per hour worked Your answer is correct. D. Technological change

Suppose two​ countries, Country A and Country​ B, have a similar real GDP per capita. Country A has an average economic growth rate of​ 2% and Country B has an average economic growth rate of​ 3.3%. In the long​ run, what can we predict about living standards in the two​ countries?

Country​ B's living standards will increase much more rapidly in the long run. Your answer is correct.

Health and education play a key role in labor productivity.

Healthier workers are more productive in two ways.​ - First, healthy people miss fewer days due to illnesses.​ - Second, healthy workers are more productive while at their jobs. -A more educated workforce is generally considered a more productive​ workforce, as individuals are better suited to new and changing production technologies.

Suppose you are discussing global trade with a friend who insists a country would be better off by restricting trade and investment with other countries. Which of the following economic responses would be the most logical for your​ discussion?

I am not sure I agree. Countries that allow more globalization have experienced higher rates of economic growth and typically can utilize greater levels of foreign direct investment to increase economic growth

The role of the entrepreneur becomes much more important in the new growth theory —the endogenous growth model—than in the traditional economic growth model because

In the new growth​ theory, entrepreneurs play a key role in the development and adoption of new and sometimes untried technologies.

When low income countries begin to experience economic​ growth, they often do so at rates much higher than current growth rates of industrial nations. Which of the following does not provide an explanation of this​ phenomenon?

Industrial countries have higher rates of growth in physical capital and developing countries are not able to invest in large quantities of capital.

cost-push inflation

Inflation caused by decreases in short-run aggregate supply.

demand-pull inflation

Inflation caused by increases in aggregate demand not matched by increases in aggregate supply.

Assume the analyst is correct that urbanization is the core driver of economic growth in China. Will China be able to continue to experience high rates of economic growth in the long​ run?

It is unlikely because the process of urbanization will eventually slow down and growth will require technological progress.

Which of the following is not one of the four major assumptions of the classical​ model? A. Wages and prices are flexible. B. People are motivated by​ self-interest. C. People suffer from money illusion. D. Pure competition exists.

People suffer from money illusion.

Strong​ rule-of-law countries grow more rapidly than weak​ rule-of-law countries. What factor will most likely improve economic growth in weak​ rule-of-law countries?

Political reform

Refer to the graph to the right. According to the economic concept of catch-up, which is​ CORRECT?

Poorer countries should grow more quickly and will be at point A.

What can​ low-income countries do in order to increase the amount of loanable funds available to firms for investment projects such as new factories or improved​ technology?

Provide savings incentives

money illusion

Reacting to changes in money prices rather than relative prices. If a worker whose wages double when the price level also doubles thinks he or she is better off, that worker is suffering from money illusion.

brain drain

Some​ well-educated individuals find very few opportunities in their own developing​ countries, and leave for industrial countries. This is called the brain drain.

Consider the figure to the right. Which of the following is responsible for the upward shifts in the​ per-worker production​ function?

Technological change

If the Commerce Department adjusts the growth rate of GDP downward for the first quarter of​ 2016, and the Bureau of Labor Statistics adjusts the number of hours worked upward for the first quarter of​ 2016, what will the Bureau of Labor Statistics do in terms of revising the figures on the growth rate of labor productivity for the first quarter of​ 2016?

The BLS will adjust the growth rate downwards.

Rule of law

The ability of a government to enforce the laws of the​ country, particularly with respect to protecting private property and enforcing contracts.

Catch-up

The prediction that the level of GDP per capita​ (or income per​ capita) in poor countries will grow faster than in rich countries.

Globalization

The process of countries becoming more open to foreign trade and investment. Globalization has benefited developing countries by allowing more access to investment funds and technology.

Foreign direct investment​ (FDI)

The purchase or building by a corporation of a facility in a foreign country. If we measure globalization by the fraction of a​ country's GDP accounted for by​ exports, we see a​ strong, positive correlation between globalization and growth in real GDP.

Labor productivity

The quantity of goods and services that can be produced by one worker or by one hour of work. Economists believe the two key factors that determine labor productivity are quantity of capital per hour worked and technological change.​ Therefore, the economic growth model focuses on these two factors to explain changes in real GDP per capita.

Per-worker production function

The relationship between real GDP per hour worked and capital per hour​ worked, holding the level of technology constant.

short-run aggregate supply curve

The relationship between total planned economywide production and the price level in the short run, all other things held constant. If prices adjust incompletely in the short run, the curve is positively sloped.

The classical economists believed that the leakage of saving would be matched by the injection of business investment.

True

The level of employment in an economy determines its real GDP.

True

Using GDP per capita in 2014​ (measured in U.S.​ dollars, corrected for differences across countries in the cost of​ living), identify which one of the following statements is​ true:

Western​ Europe, Australia,​ Canada, Japan, New​ Zealand, and the United States are​ high-income countries.

Between early 2008 and the beginning of​ 2009, a gradual stock market crash and plummeting home prices generated a substantial reduction in U.S. household wealth that induced most U.S. residents to reduce their planned real spending at any given price level. From a​ short-run Keynesian​ perspective, the predicted effects of this event on the equilibrium U.S. price level and equilibrium U.S. real GDP were​ what? The spending gap caused by the reduction in household wealth and spending between early 2008 and the beginning of 2009 can best be described as

a decrease in the price level along with a decrease in equilibrium real GDP Recessionary​ gap

According to the classical​ model, if the economy starts at full employment an increase in aggregate demand will cause all of the following to occur except A. an increase in input prices. B. a rise in real GDP above its​ long-run level. C. a decrease in unemployment. D. a decrease in wage rates.

a decrease in wage rates.

After reading a recent​ best-seller documenting a growing population of low minus income elderly people who were ill minus prepared for​ retirement, most residents of this country decide to increase their saving at any given interest rate. a. The current equilibrium interest rate. b. Current equilibrium real GDP c. Current equilibrium employment. d. Current equilibrium investment. e. Future equilibrium real GDP.

a. Decrease b. No Change c. No Change d. Increase e. Increase

Consider a country whose economic structure matches the assumptions of the classical model. Suppose that businesses in this nation suddenly anticipate higher future profitability from investments they undertake today. a. The current equilibrium interest rate. b. Current equilibrium real GDP. c. Current equilibrium employment. d. Current equilibrium saving. e. Future equilibrium real GDP.

a. Increase b. No Effect c. No Effect d. Increase e. Increase

Since it is ______ its equilibrium​ value, the interest rate would adjust _____

above; downwards

According to​ Keynes, when there is excess capacity in an​ economy, the equilibrium level of real GDP per year is determined by

aggregate demand.

A​ country's rate of economic growth is important because

an economy that grows too slowly fails to raise the living standards of its citizens.

Economic growth rates matter because

an economy that grows too​ slowly, or not at​ all, fails to raise living standards. Between 1996 and​ 2008, real GDP per capita in China grew at an average annual rate of 8.8 percent. Real GDP per capita in​ Japan, in​ contrast, grew at the much slower rate of 1.1 percent. Between 1950 and​ 1978, however, China had grown relatively​ slowly, while Japan was growing rapidly. As a​ result, in​ 2008, the standard of living in China was still well below that in Japan. For​ example, GDP per capita measured in U.S. dollars was​ $6,140 in China in 2008 but ​$34,092—more than five times higher—in Japan. If the Chinese economy can sustain the high growth rates of recent​ years, it will continue to close the gap with Japan in real GDP per capita and other measures of the standard of living.

Between early 2005 and late​ 2007, total planned expenditures by U.S. households substantially increased in response to an increase in the quantity of money in circulation. From a​ short-run Keynesian​ perspective, the predicted effects of this event on the equilibrium U.S. price level and equilibrium U.S. real GDP were

an increase in the price level along with an increase in equilibrium real GDP.

The resulting spending gap between early 2005 and late 2007 when total planned expenditures by U.S. households substantially increased in response to an increase in the quantity of money in circulation can best be described as

an inflationary gap.

Globalization has made it ____________ for developing countries to get investment funds and technology.

easier

A stonger dollar contributes to inflation.

false

The new growth theory states that

firms will add to an​ economy's stock of knowledge capital by engaging in research and development or by contributing to technological change.

Technological change is more important to​ long-run economic growth than changes in capital. The easiest way for firms to gain access to new technology is through

foreign direct investment

If the central bank wishes to prevent the equilibrium real GDP from changing in response to the oil price​ increase, it should

increase the quantity of money in circulation in order to shift aggregate demand rightward.

Suppose the​ per-worker production function was shaped as shown in the graph at right. If a country was accumulating increasing quantities of capital per hour​ worked, this country would experience

increasing labor productivity and higher levels of economic growth.

As the dollar becomes stronger in international foreign exchange​ markets, the​ short-run aggregate supply curve will shift to the​ ________ and the aggregate demand curve will shift to the​ ________.

right; left

Changes in factors of production that influence economic growth will

shift SRAS and LRAS.

A​ short-lived change in production input prices will

shift SRAS but not LRAS.

Economic growth will

slow down or stop if more capital per hour is used because of diminishing returns to capital.

Compared to the period between 1950 and​ 1973, the productivity of U.S workers between 1974 and 1995

slowed by more than one percentage point per year.

​Say's law asserts that

supply creates its own demand.

The key factors in raising standards of living in low−income countries have been increases in

technology and knowledge

All of the following are reasons why China is unlikely to maintain high enough rates of productivity growth to​ catch-up with the standard of living in the United States except

the Chinese migration of rural workers to more productive urban jobs.

The new growth theory differs from the growth theory developed by Robert​ Solow, since

the Solow growth theory focuses on technological change and the quantity of capital available to workers whereas the new growth theory states that accumulation of knowledge capital is a key determinant of economic growth.

Healthier, more educated workers tend to be more productive. Greater overall productivity per hour worked is a fundamental component of​ long-term economic growth.​ However, many very successful individuals often find few opportunities in their own developing​ countries, and leave them for industrial countries. By improving health and​ education, developing countries can generate economic​ growth, and increase incomes. This will help combat the prevalence of educated people leaving their home countries for opportunities elsewhere. That​ is, it will combat

the brain drain.

Since each​ country's real GDP is measured in a different​ currency, before one can compare the real GDPs of different​ countries, it is necessary to use

the purchasing power parities​ (PPPs) as a currency converter.

In the classical​ model, actual equilibrium real GDP ____ rise by this amount because prices ____ and the economy moves ____ from E 1 to Upper E 2. In other​ words, with

will not; rise; quickly ​Say's law and flexible interest​ rates, prices and wages would always lead to full employment at a level of real GDP of​ $18 trillion.