MACROECONOMICS - EXAM IV Fall 2004 G. Garesché 1. a. Define a speculative bubble. What conditions must exist for a speculative bubble to occur? Give two examples of speculative bubbles which have occurred in the past. b. In the early 1930s there were a large number of bank failures in this country. Explain thoroughly what made this happen. Explain the effect this had on households' consumption/saving decision. Why did this make output plunge? About how much lower was output in 1933 than it had been in 1929? c. What was the New Deal? Give an example of a program, which exists today, which was put in place during the Great Depression. Give an example of a New Deal program, which no longer exists. d. What criticisms did Keynes make about the Classical model in the Keynesian Critique? e. What did Keynes mean when he described prices as rigid?
2. a. Name four determinants of the consumption/savings decision according to Keynes. Which did Keynes feel was usually the most important determinant? Which did the Classical economists think was most important? b. Define investment. Name four determinants of investment according Keynes. Which did Keynes feel was most important determinant of investment during the Great Depression? Which did the Classical economists think was most important to how much businesses invest? c. Graph the Keynesian model on the axes below. (Be sure to label both axes). Show the effect of an increase in government spending on the graph. Label the increase in government spending on the graph. Indicate the resulting change in GDP on the graph. d. Why did Keynes think this is what governments should do during the Great Depression? Why was this a big change from what the Classical economists thought government should do? e. Explain thoroughly why it is that an autonomous increase in spending by any of the major actors in the economy will result in an increase in GDP that is greater than the increase in spending which caused it. You need to explain the process that makes the effect on GDP bigger than the spending increase.
3. a. What are the key features of the Keynesian model? b. Define the marginal propensity to consume, the marginal propensity to save and the marginal propensity to import. c. Define the spending multiplier. If the MPC =.85 and the MPM (marginal propensity to import) =.1, what is the slope of the Total Expenditures line in the Keynesian model? Calculate the spending multiplier. (Show your calculation). If government spending were reduced by $10 billion, what would be the effect on GDP? d. Define fiscal policy. What are two ways of carrying out fiscal policy? Describe three lags associated with fiscal policy. e. Define automatic stabilizers. Give an example of an automatic stabilizer, and explain why your example is one.
4. a. What economic events caused economists to shift from using the Keynesian model to the AD/AS model? What did the Keynesian model lack that caused the shift in the model that is used? b. What are the features of the AD/AS model? Explain why the AD/AS model is a combination of the Classical and the Keynesian models? c. On the axes below, graph an AD/AS model. Using data from your blue sheet, draw the curves to represent a long run or short run equilibrium that you feel illustrates the current status or health of the U.S. economy. Support your view of the economy's health by showing that your equilibrium is consistent with the current output, inflation and unemployment rate. d. How does one determine where the long run aggregate supply curve touches the top horizontal axis? e. Why does the AD/AS model suggest that policies that shift the aggregate supply curves to the right are preferable to fiscal and monetary policies? Give two examples of supply-side policy.
5. a. On the axes below, graph an AD/AS model in long run equilibrium. Place a 1 there. b. In 1990 the Persian Gulf War caused people to behave more cautiously. On the same graph show how this affected consumer spending and could have caused the 1990-91 recession. Place a 2 at this short run equilibrium. What do we call this type of short run equilibrium? c. Why was almost no fiscal policy used to help the economy recover from this recession? d. What type of policy is available to the Fed to help out the economy when it is in recession? e. Show on the graph how the economy returned to long run equilibrium, if it was not as a result of fiscal or monetary policy. What do we call this mechanism? Identify the resulting equilibrium with a 3. f. Describe what evidence exists that there has been an improvement in economic performance during the 20 th century in the U.S. What accounts for the improved performance?
6. a. On the axes below, graph a short run and a long run Phillips curve. What trade-off does the short run Phillips curve show? At what inflation rate do the two curves intersect? At what unemployment rate do the two curves intersect? b. Short run Phillips curves swirled upward and rightward during the 1970s and early 1980s. What made them shift up? What made them shift right? Why does that mean that even when the economy was not in recession, the unemployment rate tended to be significantly higher than it is today? c. Explain why even a moderately high inflation of 10-14% over a period of years is a serious economic problem that must be corrected. (This requires a thorough explanation). Why does this explain why U.S. GDP grew faster in the 1990s than in the 1980s? d. Explain why some economists describe activist monetary and fiscal policy during a recession as being similar to giving a person over-the-counter cold medication for a cold. Why might the Fed's actions in the last few years be characterized as activist?
f. List five policy objectives or goals a central bank could pursue. Which three has the Fed actively pursued in the last five years?