Introduction

Question 1

Macroeconomics

Answer 1

• The study of the behavior of large collections of economic agents
• It focuses on the aggregate behavior of consumers and firms, the behavior of governments, the overall level of economic activity in individuals and countries, the economic interactions among nations, and the effects of monetary and fiscal policy

Question 2

Models

Answer 2

• Built to explain macroeconomic phenomena
• The important phenomena are long-run growth and business cycles
• Built up from from microeconomic principles (microfoundations approach)

Question 3

Long-run growth

Answer 3

The increase in a nation’s productive capacity and average standard of living that occurs over a long period of time

Question 4

Business cycles

Answer 4

The short-run ups and downs in aggregate economic activity

• Business cycles may have many causes, and causes important in one business event may be very unimportant in another

Question 5

Gross Domestic Product (GDP)

Answer 5

• The quantity of goods and services produced within a country’s borders over a particular period of time
• The time series of GDP can be separated into trend and business cycle components.

Question 6

When it useful to take the natural logarithm of the time series

Answer 6

When the slope of the graph is close to the growth rate

Question 7

Business cycle component

Answer 7

The deviations from a smooth trend fit to the data

Question 8

Macroeconomic models

Answer 8

• Organized structures structures used to explain long-run economic growth
• A macroeconomic model captures the essential features of the world needed to analyze a particular macroeconomic problem.
• Macroeconomic models should be simple, but they need not be realistic

Question 9

Basic structure of a macroeconomic model is a description of the following features

Answer 9

• Consumers and Firms
• The Set of Goods that Consumers Consume
• Consumers’ Preferences
• The Production Technology
• Resources Available

Question 10

Additional features of the model required to make economic predictions

Answer 10

• The goals of consumers and producers (Assume the optimize)

- How consistency is achieved in terms of the actions of consumers and producers (The economy must be in equilibrium)

Question 11

Competitive equilibrium

Answer 11

Assume goods are bought and sold on markets in which consumers and firms are price takers

Question 12

What do we learn from macroeconomic analysis

Answer 12

• What is produced and consumed in the economy is determined jointly by the economy’s productive capacity and the preferences of consumers.
• In free market economies, strong forces tend to produce socially efficient economic outcomes.
• Unemployment is painful for individuals, but it is a necessary evil in modern economies.
• Improvements in a country’s standard of living are brought about in the long run by technological progress.
• A tax cut is not a free lunch
• Credit markets, banks play key roles in the macroeconomy.
• What consumers and firms anticipate for the future has an important bearing on current macroeconomic events.
• Money takes many forms, and society is much better off with it than without it. Once we have it, however, changing its quantity ultimately does not matter.
• Business cycles are similar, but they can have many causes.
• Countries gain from trading goods and assets with each other, but trade is also a source of shocks to the domestic economy.
• In the long run, inflation is caused by growth in the money supply.
• If there is a short-run tradeoff between output and inflation, that has very different implications relative to the relationship between nominal interest rates and inflation.
• Read on p 33

Question 13

Aggregate Productivity

Answer 13

• A measure of productivity in the aggregate economy is average labor productivity (Y(real GDP) / N(employment))

Important both in explaining business cycles, and in explaining long run growth in standards of living.

Question 14

Unemployment and vacancies

Answer 14

• The unemployment rate is measured as the number of people actively searching for work, as a percentage of the labor force
• The unemployment rate can be explained by demographics, the generosity of unemployment insurance programs, and shocks to the economy that cause business cycles.
• The Beveridge curve is a negative relationship between the vacancy rate ( job postings by firms divided by total employment plus vacancies) – and the unemployment rate
• Basically, the number of vacancies relative to unemployment is a measure of labor market tightness, and tightness tends to increase in economic booms and decrease in recessions
• But the Beveridge curve has shifted. This is sometimes ascribed to long-run changes in the labor market – an increase in the mismatch between the skills needed by firms, and the skills unemployed workers possess.

Question 15

Taxes, Government Spending and the Government deficit

Answer 15

• Increases in government activity in general causes crowding out of private economic activity - reduction in private consumption expenditures
• The government surplus/saving is the difference between taxes and spending
• The government deficit is the negative of government surplus where government spending exceeds taxes

Question 16

Inflation rate

Answer 16

• Rate of change in the average level of prices

- In much of the world inflation is deemed to be too low

Question 17

Interest rates

Answer 17

• Affects how much consumers borrow and lend and how much firms invest in new plant and equipment
• Movements in interest rates are an important element in the economic mechanism by which monetary policy affects real magnitudes in the short run
• Real interest rate is the nominal interest rate minus the expected rate of inflation
• Over the long run, the Fisher effect comes into play. The Fisher effect is a positive relationship between the nominal interest rate and the inflation rate

Question 18

Credit markets and the financial crisis

Answer 18

Credit market imperfections

• Asymmetric information refers to the situation where the economic actors on one side of a market have more information than the economic actors on the other side of the market
• Limited commitment refers to a borrowers lack of incentive to repay in the credit market - Lending institutions attempt to solve this incentive problem by requiring a that a borrower post collateral
• The financial crisis caused macroeconomists to focus more on financial factors as a cause of business cycles.
• Financial market friction can be reflected in interest rate spreads – the difference between interest rates on risky assets and safe assets.
• Another feature of the financial crisis was the large drop in asset prices, particularly the price of housing, that acted to propel a wave of mortgage foreclosure
  market.

Question 19

The current account surplus

Answer 19

• The world has become more open to trade in goods and assets over time
• More trade has a positive effect on general economic welfare, as it allows countries to specialize in production and exploit their comparative advantages, but it can also expose a country to the business cycles from abroad
• The current account surplus (measure of the balance of trade) is net exports (exports - imports) plus net factor payments ( net income from abroad)
• When a country runs a negative current account surplus, it is importing more than it is exporting, and it pays for these net imports by borrowing from the rest of the world

This need not be a bad thing, as a current account deficit allows a country to smooth its consumption relative to its income and can permit investment in plant and equipment that can be used to produce more in the future.