Lecture notes on Macroeconomic principles

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_________________________________________________________    MACROECONOMICS IN CONTEXT, 1e STUDENT STUDY GUIDE ___________________________________________________________    This guide has been compiled by Marjolein van der Veen, with contributions by Julie  A. Nelson.   It accompanies Macroeconomics in Context, First Edition by Neva Goodwin, Julie A.  Nelson, and Jonathan Harris (M.E. Sharpe, 2008).  Each chapter of this Student Study Guide includes the following materials:  • Overview  • Objectives  • Key Term Review  • Active Review Questions   • Self Test  • Answers to Active Review Questions  • Answers to Self Test      This Guide is available electronically from  http://www.ase.tufts.edu/gdae/publications/textbooks/macroeconomics.html or  www.gdae.org.     GLOBAL DEVELOPMENT AND ENVIRONMENT INSTITUTE  Tufts University  Medford MA 02155, USA  http://ase.tufts.edu/gdae      ©Copyright 2008 Global Development and Environment Institute, Tufts University     CHAPTER 1  ECONOMIC ACTIVITY IN CONTEXT  Macroeconomics in Context (Goodwin, et al.)   Chapter Overview  This chapter introduces you to the basic topics of macroeconomics, and presents the main macroeconomic goals: 1) living standards growth, 2) stability and security, and 3) financial, social, and ecological sustainability. The chapter highlights that the goal of living standards growth may or may not contribute to the general goal of human well- being. The chapter also provides a brief overview of the major historical developments in macroeconomics, from classical economics, to Keynesian and monetarist economics, st to the classical/Keynesian synthesis, and finally to the challenges in the 21 century.     Chapter Objectives    After reading and reviewing this chapter, you should be able to: 1. Distinguish the concerns of macroeconomics from microeconomics. 2. Define the difference between normative and positive questions. 3. Discuss the relationship between economics and well-being. 4. Identify and describe the three main macroeconomic goals. 5. Identify and distinguish the major historical traditions of economic thought.     Key Terms    economics labor productivity microeconomics business (trade) cycle macroeconomics precautionary principle unemployment classical economics inflation division of labor macroeconomy specialization global economy laissez-faire economy economic actor (agent) Say’s Law positive questions aggregate demand normative questions Keynesian economics well-being fiscal policy living standards growth monetary policy economic growth monetarist economics economic development   1-1   Active Review Fill in the Blank 1. While the study of economic activities of individuals, households, and business at the sub-national level is the concern of _____________, the study of economic activities of the national and global level is the concern of __________________. 2. Questions about facts or “how things are” are __________ questions, while questions about values and “how things should be” are _____________ questions. 3. The three main macroeconomic goals identified in this chapter are ___________, ________________, and __________________. 4. The process of moving from a situation of poverty and deprivation to a situation of increased production and plenty is referred to as ___________________. 5. The increase in the level of production in a country or region is called ______________ growth while improvements in diet, housing, medial attention, education, working conditions, access to care, transportation, communication, entertainment, etc. is called _________________ growth. 6. The fluctuations in the level of production, between recessions on the one hand and booms on the other hand, is called __________________. 7. The goal that recognizes a serious responsibility to future generations is the goal of ____________________. 8. The school of economics that is associated with the idea that individual self-interest is a positive force and that governments should let markets function without interference is called ______________. 9. The economist who argued that the market mechanism can fail by leaving insufficient demand, and that governments could intervene by increasing aggregate demand was named _____________. 10. The school of thought that argued that governments should aim for steadiness in the money supply rather than play an active role is called _______________. True or False 11. Economic phenomenon such as the rate of unemployment and inflation are studied in microeconomics.   1-2 12. Living standards growth is defined as increases in the level of production in a country or region. 13. During a recession, the economy often has higher rates of unemployment, whereas during a boom, the economy often has higher rates of inflation. 14. Monetarists believe the government should use monetary policy to boost aggregate demand during a recession. 15. According to the classical/Keynesian synthesis, in the short run we are in the Keynesian world, and in the long run we are in the classical world. Short Answer 16. What types of questions would concern microeconomics, versus macroeconomics? 17. How have economists traditionally defined “economic growth,” and how is that different from “living standards growth”? 18. What are the “three basic economic questions” that economists often address when examining how much economic output is produced? 19. Once countries already have a high level of production, how might they achieve living standards growth? 20. Why is the goal of stability and security important to many people? What problems typically emerge during periods of instability? 21. The goal of sustainability requires that we address what three questions? 22. Explain the how the classical school views the role of markets and government intervention in fighting business cycles. 23. Explain how Keynesian economics views the role of markets and government intervention in fighting business cycles. 24. Explain how Monetarist economics views the role of markets and government intervention in fighting business cycles. 25. How does the classical/Keynesian synthesis combine elements from both the classical and Keynesian schools? 26. What two developments are demanding new ways of looking at the economic world st in the 21 century? What kinds of sustainability questions do they raise?   1-3 Self Test 1. With what kinds of topics does macroeconomics concern itself? a. Economic activities of individual firms, households, and other organizations b. Forces of supply and demand in a particular market c. Consumer behavior and firms output decisions d. The labor market, wages, and hiring decisions. e. Aggregate economic phenomena like the rate of unemployment and inflation. 2. Which of the following is an example of a normative question? a. What is the nation’s rate of economic growth? b. What is the nation’s rate of inflation? c. What is the nation’s rate of unemployment? d. What is the nation’s level of GDP? e. Is the goal of sustainability of greater importance than the goal of economic growth as st we move into the 21 century? 3. Which of the following is one of the three macroeconomic goals discussed in the text? a. Growth in the size of corporations b. Living standards growth c. Growth in trade and globalization d. Technological innovation e. None of the above 4. Which of the following is not an example of one of the three macroeconomic goals discussed in the text? a. Preventing the economy from experiencing too much unemployment. b. Preventing the economy from experiencing too much inflation. c. Keeping living standards high enough for people to live decent, meaningful lives. d. Making sure the economy is sustainable into the future. e. Providing the best environment for corporations.   1-4 5. What explains the fact that the value of global production has grown by a factor of 4.6, while the value of global production per capita has grown by a factor of 2? a. the increase in global production has not kept up with the growth in global population b. the increase in global production has occurred simultaneously with the decline in global population. c. the increase in global production has occurred simultaneously with the growth in the global workforce. d. the increase in global production has occurred simultaneously with the decline in the global workforce. e. the growth in the global working age population contributing to global production has been greater than the growth in the global population. 6. How is labor productivity defined? a. The level of output produced per capita. b. The level of output produced per worker (or worker-hour). c. The level of output produced as a share of GDP. d. The level of human capital in the workforce. e. The level of output produced per capital input. 7. What problems are we most likely to see at which stage of the business cycle? a. High inflation during recessions. b. High unemployment during booms. c. Low inflation during booms. d. High unemployment during recessions. e. Both high unemployment and high inflation during booms. 8. Why is the instability of the business cycle a problem? a. During recessions there is high unemployment, and resources are underutilized. b. High unemployment is associated with individual and social stress, such as suicide, domestic violence, illness and crime. c. During booms, high inflation can erode purchasing power, savings and pensions. d. Unpredictable fluctuations in rates of inflation, interest rates, and foreign exchange rates make it difficult for individuals and organizations to plan for the future. e. all of the above.   1-5 9. Which of the following does not describe the economic events of the Great Depression? a. Stock markets plummeted in the 1929 stock market crash. b. A lack of confidence in banks led to runs on the banks and bank failures. c. Production dropped by about 30% between 1929 and 1933. d. The unemployment rate peaked to 25% at the height of the depression. e. The economic crises was short lived and markets quickly adjusted back to equilibrium. 10. Which of the following are the three dimensions of sustainability as discussed in the text? a. ecological, financial, and social sustainability b. ecological, financial, and political sustainability c. ecological, financial, and cultural sustainability d. ecological, technological, and human sustainability e. ecological, technological, and social sustainability 11. Which of the following is not an issue concerning of social sustainability? a. the disparities between the “haves” and the “have nots.” b. the ability of the next generation to contribute to a healthy economy and society c. the existence of national debt and the draining of financial resources. d. the creation of social disruption and political strife e. the ability of the next generation to experience social and political participation and inclusion. 12. Which of the following best describes the precautionary principle? a. It is incumbent on society to prove if an activity is unsafe to natural systems or human health. b. We should err on the side of caution when dealing with natural systems or human health. c. The benefits of economic production and growth outweigh the risks of damage to natural systems or human health. d. Business should not have to prove a product to be safe before being released on the market; rather a product must be proven unsafe before it is banned and pulled from the market. e. We should take precautions before engaging in risky investment.   1-6 13. Which of the following is not one of the ideas associated with the school of classical economics? a. specialization and the division of labor b. laissez-faire and the functioning of markets free of government intervention c. the pursuit of individual self-interest leads to positive economic outcomes. d. supply creates its own demand e. markets sometimes fail, necessitating government intervention. 14. Which of the following is not one of the ideas of Keynesian economics? a. An economy can experience insufficient demand b. Governments can step in to help boost aggregate demand c. Active use of fiscal policy can help keep aggregate demand high and employment rates up. d. Governments should focus on keeping the money supply steady e. Lowering interest rates alone may be insufficient if investors lack the confidence to engage in spending. 15. Which of the following best distinguishes fiscal from monetary policy? a. Monetary policy deals with the manipulation of government spending and taxation. b. Fiscal policy deals with the manipulation of interest rates and the money supply. c. Fiscal policy deals with the manipulation of levels of government spending and taxation. d. Monetary policy deals with both the manipulation of government spending and taxation, and interest rates and the money supply. e. Fiscal policy deals with both the manipulation of government spending and taxation, and interest rates and the money supply. 16. Which of the following was one of Keynes’s suggested solutions, and was was not generally adopted in the U.S. in the post-war era? a. the use of fiscal policy to stabilize the business cycle. b. the use of monetary policy to stabilize the business cycle. c. the involvement of government in controlling of the level and direction of national investment. d. the role of government in purchasing goods and services to stimulate aggregate demand. e. the role of government in manipulating taxation to stimulate aggregate demand.   1-7 17. Which of the following is not one of the ideas associated with monetarist economics? a. Bad government monetary policies are the cause of economic crises b. It was easy credit, low interest rates and high levels of money supply that led to the overspending of the late 1920s. c. The Great Depression of the 1930s was caused primarily by tight money policies. d. Governments should not use active monetary policy, but should keep the money supply stable. e. There are times when the government should take an active role by intervening with fiscal policy. 18. Which of the following best describes the classical/Keynesian synthesis? a. In the short run we are in the classical world, but in the long run we are in the Keynesian world. b. In the short run we are in the Keynesian world, but in the long run we are in the classical world. c. We are always in the short run which is characterized by the Keynesian view. d. We are always in the long run, which is characterized by the classical view. e. The classical and Keynesian schools both share the same basic view of economic agents engaging in rational, optimizing behavior. 19. According to the text, which of the following issues, not previously a major concern st of macroeconomics, must macroeconomics confront in the 21 century? a. The ecological sustainability of our reliance on fossil-fuel based economic growth b. The social sustainability of the traditional model of economic development with the persistence of global poverty. c. The problem of business cycle fluctuations in unemployment and inflation. d. A and b only e. None of the above.   1-8 st 20. Which of the following characterizes the environmental challenges of the 21 century? th a. The impressive growth of global GDP in the 20 century was accompanied by a dramatic increase in CO emissions. 2 b. Economists are beginning to realize that there are limits to the capacity of the environment to absorb the by-products of economic growth. c. Economists are increasingly questioning the ability of technological advancements to keep problems of resource depletion and pollution at bay. d. If continued at the current rate, the emissions of CO and other greenhouse gasses may 2 lead to dramatic disturbances to our environment and economy. e. all of the above. Answers to Active Review Questions 1. microeconomics, macroeconomics 2. positive, normative 3. living standards growth, stability and security, sustainability 4. economic development 5. economic, living standards 6. the business cycle 7. sustainability 8. classical economics 9. John Maynard Keynes 10. monetarist economics 11. False. They are studied in Macroeconomics. 12. False. Economic growth, not living standards growth, is defined as increases in the level of production in a country or region. 13. True. 14. False. Monetarists argued that governments should focus on keeping the money supply steady, even in a recession when unemployment was high. 15. True. 16. Microeconomics concerns itself with decision-making of individual consumers, firms and other organizations, such as how much to consume or produce of a product, while macroeconomics deals with aggregate production and expenditure, the level of unemployment, inflation, and interactions with the global economy. 17. Economists have traditionally defined economic growth in terms of production of goods and services, whereas the concept of “living standards growth” encompasses the improvement in the quality of diet and housing, transportation and communication, health care, education, working conditions, entertainment, and even political freedom and social inclusion. 18. The three basic questions are: what is produced, how is it produced, and for whom is it produced.   1-9 19. Once countries achieve a high level of production, they may achieve living standards growth by improving cultural, educational and environmental conditions, raising the quality of work-life, and promoting more equity. 20. The instability over the business cycle can be accompanied by high rates of unemployment, which is associated with falling incomes and social stress, like suicide, domestic violence, illness and crime. Alternatively the instability may result in inflation, which can erode the purchasing power of income, or wipe out the value of savings and pensions. 21. The goal of sustainability requires that we address whether economic activities are financially sustainable, whether they are socially sustainable, and whether they are ecologically sustainable. 22. The classical school believes in the smooth functioning of market mechanisms, and that they work best when left alone. They generally do not think governments should intervene, and think that often government intervention makes things worse. 23. Keynesian economics believes markets often fail and governments have a role to intervene, especially in boosting aggregate demand during downturns. 24. Monetarist economics believes that the government should pursue a steady money supply and not use active monetary policy interventions over the course of the business cycle. 25. The classical/Keynesian synthesis believes that in the short run we are in the Keynesian world (where markets fail to adjust and prices remain sticky), but in the long run we are in the classical world in which markets adjust and prices are flexible. 26. Two developments that are demanding new ways of looking at the economic world in st the 21 century are 1) the environmental impact of long-term fossil-fuel based economic growth, particularly with the dramatic rise in CO emissions; and 2) the persistence of 2 substantial global poverty and its threat to social sustainability. Answers to Self Test Questions 1. e 2. e 3. c 4. e 5. a 6. b 7. d 8. e 9. e 10. a 11. c 12. b 13. e 14. d 15. c 16. c 17. e   1-10 18. b 19. d 20. e   1-11 Chapter 2  Useful Tools and Concepts  Macroeconomics in Context (Goodwin, et al.)      Chapter Overview This chapter introduces standard concepts of economic modeling, efficiency, scarcity, opportunity cost, the Production Possibilities Frontier, and the advantages of market systems, and includes a review of graphing techniques. In this chapter you will see these concepts set into a broader context of concern for well-being. The chapter discusses the institutional requirements of markets and introduces the concepts of externalities, public goods, market power, transaction costs, information and expectations and concern for human needs and equity in order to demonstrate why markets, while useful, are not on their own sufficient for organizing economic life in the service of well-being. Chapter Objectives After reading and reviewing this chapter, you should be able to: 1. Distinguish and differentiate among the different methods of investigation: empirical investigation, theoretical investigation, and historical investigation. 2. Understand the concept of economic tradeoffs (or opportunity costs) in the face of abundance or scarcity. 3. Interpret and apply the Production Possibilities Frontier. 4. Distinguish the different meanings of the term “market,” and describe how the market is understood in the basic neoclassical model. 5. Describe the institutional requirements of markets. 6. Identify the advantages and limitations of markets. Key Terms empirical investigation efficiency time series data technological progress negative (or inverse) relationship market positive (or direct) relationship institutions theoretical investigation basic neoclassical (traditional model microeconomic)model ceteris paribus private property historical investigation implicit contract abundance explicit contract scarcity physical infrastructure production possibilities frontier public goods opportunity cost free riders   2-1 externalities static analysis transactions costs dynamic analysis market power market failure Active Review Fill in the Blank 1. The observation and recording of specific phenomena of concern is called _____________ investigation, whereas the analysis based in abstract thought is called ___________ investigation. 2. When researchers study past events, they are conducting a(n) _______________ investigation. 3. The Latin phrase that means “all else constant” or “other things equal” is ____________. 4. A diagram that shows the tradeoffs between production of two goods is called a(n) _________________. 5. You’re deciding whether to take an Economics course, or to take an Anthropology course. The ___________________ cost of taking the Economics course is the course you’re having to forego, the Anthropology course. 6. A process that achieves the maximum value of output from the given set of inputs can be described as _______________. 7. If someone enjoys the benefit of a well-paved highway but refuses to pay for it, they would be considered a __________. 8. You decide to buy a used car. You discover that it is hard to get information on the quality of the used cars that are available. You have trouble communicating with the car dealer. It takes a considerable amount of time to get the information you need to successfully get the car you had in mind. In other words, buying a used car turns out to be an activity with high ________________ costs. 9. A new factory begins discharging pollutants into a previously pristine river. Fish in the river begin to die, and people who make their living through fishing have trouble maintaining their catch. This factory is generating negative ______________________. 10. A professional musician practices piano every afternoon. Her neighbor listens to the music and enjoys it. Through her activity, the musician is creating a positive _____________________.   2-2 True or False Questions 11 to 13 refer to the production possibilities frontier shown below. 120 B C D A 30 0 50 100 Quantity of Butter 11. In the graph shown above, at point B, society is producing the maximum possible amount of butter. 12. To move from point A to point B, society would have to cut down on its gun production and increase butter production. 13. Starting from point B, society would have to shift substantial resources to increase gun production. 14. A public good is a good that is consumed by the public. 15. Public goods, externalities, transactions costs, market power, the difficulty of getting information, and concern for human needs and equity are all examples of issues that lead to market failure. Short Answer 16. Assume you see that two macroeconomic variables are correlated with each other. But you want to know if there’s an underlying or causal relationship between the two variables. Would you use an empirical or theoretical investigation? Explain why.   2-3 Quantity of Guns17. Why does a production possibilities frontier with increasing opportunity costs have a bowed-out shape? 18. Consider the following PPF: 120 B C D A 30 0 50 100 Quantity of Butter Identify points that are a) inefficient and b) unattainable. How might a country be able to produce a combination of goods and services that was otherwise unattainable? 19. Consider the following Production/Maintenance frontier.   2-4 Quantity of GunsWhat would the future PPF look like if a high level of resource maintenance (e.g. point B) were chosen now? If a high level of resource depleting production (e.g. point A) were chosen now? 20. Provide an example of a market that fits the first meaning of markets (as a physical place), and an example of a market that fits the second definition (as an institution). 21. Name the two actors in the basic neoclassical (or traditional microeconomic) model of economics, and identify the assumptions the model makes of these two actors. 22. What does the basic neoclassical, or traditional, model of economics assume about markets? 23. List two advantages of markets identified by the authors of the text. 24. Identify the four institutional requirements of markets. 25. Identify six disadvantages of markets (i.e. cases of market failures).   2-5 Problems 1. Given the following data: Year Unemployment Rate Inflation Rate (percent) (percent per year) 1984 7.5 3.8 1985 7.2 3.0 1986 7.0 2.2 1987 6.2 2.7 Source: Economic Report of the President a. Plot the unemployment data on a time series graph: B. Plot the inflation data on a time series graph: b. Now plot the unemployment and inflation data using a scatter diagram. Over any period of years is there a positive relationship between the two variables? Over any period is there a negative relationship?   2-6 2. Suppose that a society could produce the following maximum combinations of schools and airplanes in a given year: Alternative Quantity of schools Quantity of airplanes A 100 0 B 80 30 C 60 50 D 40 60 E 20 65 F 0 68 a. Draw a production possibilities frontier (PPF) with schools on the horizontal axis and airplanes on the vertical axis. Assume that the dots define a complete curve. b. Is it possible and/or efficient for this society to produce 50 airplanes and 80 schools? c. If society is currently producing at alternative C, then the opportunity cost of increasing the output of schools from 60 to 80 is __________ airplanes. d. If society is currently producing at alternative E, then the opportunity cost of increasing the output of schools from 20 to 40 is ____________ airplanes. e. Is the opportunity cost of producing schools higher or lower moving from alternative C to B, than moving from E to D? Explain why.   2-7 Self Test 1. Suppose an investigator has 50 years of data on rates of industrial production and annual accumulations of CO2, and discovers a positive relationship between the two variables. This is an example of what type of investigation? a. Theoretical investigation b. Empirical investigation c. Historical investigation d. Both A and B. e. A, B, and C. 2. What does the Production Possibilities Frontier represent? a. A catalog of all possible production options, represented as percentages. b. The tradeoffs between production and consumption options. c. The tradeoffs between possible production levels for two goods. d. The amount that a society could produce if it devoted all its resources to producing one good. e. The possible gains from international trade in two or more goods. 3. Which of the following factors could expand a society’s production possibilities frontier? a. Increased butter production. b. Shifting from one product to another. c. Producing air pollution. d. Depleting resources now instead of later. e. Technological innovations. Questions 4 and 5 refer to the following scenario: C D A B Pencils   2-8 Erasers

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