Principles of MacroeconomicsHartmann

Fall 2015Key Wkt #4

Good luck studying for the exam!

  1. Simple spending multiplier = 1/(1-mpc) = 1/(1-.9) = 1/.1 = 10
  1. Movementalong AEto the left ( in GDP factor); shift down (change in nonprice level); -50; -50
  2. shift down (change in nonGDP/nonincome factor); shift down (change in nonprice level); -50; -50
  3. shift down (change in nonGDP/nonincome factor); shift down (change in nonprice level); -60; -60

Why a decreae? If savings increase, then consumption decreases.

  1. shift up (change in nonGDP/nonincome factor); shiftup (change in nonprice level); 50; 50
  2. shift up (change in nonGDP/nonincome factor); move along AD to the right ( in PL ); 70; 70
  3. shift up (change in nonGDP/nonincome factor); shift up (change in nonprice level); 80; 80

Why? foreign price level changed

  1. shift down (change in nonGDP/nonincome factor); shift down (change in nonprice level) -100;-100

Why? foreign GDP changed

Why is the shift in AD in part (a) equal 50? Recall from lecture notes the following problem:

-MPC = .8; Price Level = 100; C= 180+.8*RGP; I*= 60; G=X=M = 0

-the original equilibrium GDP demanded was 1200

-Then planned autonomous investment rose by 20. This lead to a rise in RGDP by 100.

  •  in GDP =  in initial spending X SSM = (20) * (1/.2) = 20 *5 = 100

-So the new equilibrium GDP demanded was 1300.

  1. a) No. Real GDP only will rise by $16b. This is insufficient to get us back to full employment. Real GDP must rise by $20b to get back to potential output.

Just in case you did not notice it was a balanced budget this is how you would figure out by how much real gdp would rise.

real gdp =G* 1 + T*(-1)*mpc 1

(1-mpc) (1-mpc)

= (16)(4) + 16(-3)= $16b

b) We no longer have a balanced budget and must calculate the change in real gdp the long way.

real gdp =G* 1 + T*(-1)*mpc 1

(1-mpc) (1-mpc)

= (16)(4) + 16(3)= $112b

You now would be producing above potential output.

  1. This problem is very similar to the one done in lecture. Answer using the cookie cutter approach on page 3 of the assignment.

There has been a shift in the composition of what consumers purchase. They substitute from the relatively more expensive foreign goods to the relatively cheaper U.S. products. This leads to a shift in the NX curve. (It is a shift because it is a nonincome/nongdp change.)

If NX rises => then AE rises (b/c of nonincome change) => then AD for the U.S. rises (b/c of nonprice change) => This leads to a rise in real GDP and price level in the short run.

Note: AD shifted because a nonprice change raised NX expenditures. Prices of Japanese and American products did not change (initially), just the purchasing power of the USD relative to the Japanese Yen, for instance, has changed.

How does the economy get back to the long run equilibrium (i.e., back to potential output)? There are three possible approaches: Classical, Keynesian, Federal Reserve use of monetary policy. The homework question requests you the graph the first approach.

Classical approach: In the long run, workers will demand an increase in nominal wages. Why? Their real wages have fallen (between point A and B) because of the rise in the price level. (The real payments to all resources have fallen as well. We just focus our discussion on wages because the labor input is the biggest component of production costs.) The contracts for labor and other input resources are renegotiated in the long run. This increases the cost of production and shifts the SRAS curve to the left. SRAS shifts until it reaches the new long run equilibrium at point c. Note that this leads to a higher price at the original production level (i.e., potential output) in the long run.

Don’t forget to label the price expected when draw the SRAS curve.

You now can imagine why Janet Yellen, the Chairman of the Federal Reserve, is so concerned about the U.S. producing above our potential output.

An alternative way to get back to long-run equilibriumis for the government to decrease government spending or increase taxes as they did in 1968 as discussed in your textbook. This would have led to a decrease in AD back to the original level.

The second alternative way to get back to long-run equilibriumis for Yellen to use monetary policy to raise interest rates to counteract the inflationary pressure caused by increased spending. This would lower AD and return us to original equilibrium.

Long-long run analysis - note that a rise in net exports does not shift our long run maximum sustainable output/ productivity of our economy. There was a change in what we actually produce, but not what we can potentially produce over a long period of time. Our overall productive capability has not changed. Thus, the LRAS will not shift in this scenario. Note the difference between this problem and the problems we did in class.

  1. Distinguish between discretionary fiscal policy and automatic stabilizers. See textbook. Give some examples of automatic stabilizers. See textbook. Explain the impact of automatic stabilizers on disposable income/real GDP as the economy moves through the business cycle. They essentially dampen the drop in real GDP (i.e., reduce the magnitude of the fluctuations of GDP) and make the economy more stable. See textbook discussion of this. Finally, which one is used to solve short-term problems and which one is more effective for long- term problems?