Transcript
160Miller• Economics Today, Nineteenth Edition
Chapter 11Classical and Keynesian Macro Analyses159
Answers to Questions for Critical Analysis
Why U.S. Nominal Wages Have Been Slow to Adjust? (p. 239)
Why do you suppose that throughout this decade the rate of employment among male workers has exceeded the unemployment rate among female workers?
Compared with the unemployment rate among female workers, the rate of unemployment among male workers has been higher throughout this decade because men have lagged behind women in obtaining education and training that firms have demanded.
Variations in Credit-Market Sentiment and Aggregate Demand Shocks
(p. 243)
If the credit-spread were to widen suddenly and hereby signal weakened credit-market sentiment, would this event foreshadow a future positive or negative aggregate demand shock? Explain.
A weakened credit-market sentiment is indicative of a future decline in total real expenditures. Hence,
if the credit spread were to widen suddenly, the weak credit-market sentiment would foreshadow a future positive aggregate demand shock.
You Are There
A Japanese Economist Tells His Government, “I Told You So!” (p. 247)
1. How do you suppose that the increase in Japan’s consumption tax rate affected the nation’s equilibrium price level, other things being equal?
As a result of the increase in the consumption tax rate, Japan’s aggregate demand curve shifted downward and to the left. Other things being equal, the nation’s equilibrium price level would fall.
2. Why do you suppose that a number of economists are advising the Bank of Japan to boost the nation’s money supply when the government implements its additional consumption tax increase?
When the government implements the additional consumption tax increase, an increase in the nation’s money supply would offset some of the negative effect of the tax increase on equilibrium real GDP by inducing an increase in aggregate demand.
Issues and Applications
How Do Large Firms Influence Macroeconomic Shocks? (pp. 259–260)
1. How has the fact that thousands of people from Puerto Rico have moved to the United States to search for jobs likely influenced Puerto Rico’s official unemployment rate? Explain your reasoning.
The fact that people moved from Puerto Rico to the United States has reduced Puerto Rico’s total number of workers (or the size of labor force) as well as the number of unemployed. The official unemployment rate would fall as a result.
2. Why do you suppose that the effects of the minimum-wage-generated aggregate supply shock in Puerto Rico have persisted for several years? (Hint: the minimum wage persistently has exceeded market clearing wages for a significant fraction of the Puerto Rican labor force.)
The fact that the minimum wage has persistently exceeded market clearing wages for a significant fraction of the Puerto Rican labor force, the surplus in the labor market and thus the effects of the aggregate supply shock would have persisted for some time.
Research Project
1. For the latest labor force, employment, and unemployment data for Puerto Rico provided by the U.S. Bureau of Labor Statistics, see the Web Links in MyEconLab.
2. To view current indicators regarding activity in the Puerto Rican economy, see the Web Links in MyEconLab.
Answers to Problems
11-1. Consider a country whose economic structure matches the assumptions of the classical model. After reading a recent best-seller documenting a growing population of low-income elderly people who were ill prepared for retirement, most residents of this country decide to increase their saving at any given interest rate. Explain whether or how this could affect the following:
a. The current equilibrium interest rate
b. Current equilibrium real GDP
c. Current equilibrium employment
d. Current equilibrium investment
e. Future equilibrium real GDP (see Chapter 9)
a. Because saving increases at any given interest rate, the desired saving curve shifts rightward. This causes the equilibrium interest rate to decline.
b. There is no effect on current equilibrium real GDP because in the classical model, the vertical long-run aggregate supply curve always applies.
c. A change in the saving rate does not directly affect the demand for labor or the supply of labor in the classical model, so equilibrium employment does not change.
d. The decrease in the equilibrium interest rate generates a rightward and downward movement along the demand curve for investment. Consequently, desired investment increases.
e. The rise in current investment implies greater capital accumulation. Other things being equal, this will imply increased future production and higher equilibrium real GDP in the future.
11-2. Consider a country with an economic structure consistent with the assumptions of the classical model. Suppose that businesses in this nation suddenly anticipate higher future profitability from investments they undertake today. Explain whether or how this could affect the following:
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. Desired investment increases, so the equilibrium interest rate rises.
b. There is no effect on current equilibrium real GDP because in the classical model the vertical long-run aggregate supply curve always applies.
c. A change in desired investment does not directly affect the demand for labor or the supply of labor in the classical model, so equilibrium employment does not change.
d. The decrease in the equilibrium interest rate generates a rightward and upward movement along the supply curve of saving. Consequently, equilibrium saving increases.
e. The rise in current investment implies greater capital accumulation. Other things being equal, this will imply increased future production and higher equilibrium real GDP in the future.
11-3. “There is absolutely no distinction between the classical model and Chapter 10’s model of long-run equilibrium.” Is this statement true or false? Support your answer.
False. In fact, there is an important distinction. The classical model of short-run real GDP determination applies to an interval short enough that some factors of production, such as capital, are fixed. Nevertheless, the classical model implies that even in the short run the economy’s aggregate supply curve is the same as its long-run aggregate supply curve.
11-4. Suppose that the Keynesian short-run aggregate supply curve is applicable for a nation’s economy. Use appropriate diagrams to assist in answering the following questions:
a. What are two events that can cause the nation’s real GDP to increase in the short run?
b. What are two events that can cause the nation’s real GDP to increase in the long run?
a. A decline in nominal wages is one event. A decrease in the cost of any other important input, such as energy, is another.
b. A technological improvement is one event. Greater capital accumulation and increase
labor-force participation are others.
11-5. What determines how much real GDP responds to changes in the price level along the short-run aggregate supply curve?
The key elements determining the slope of the short-run aggregate supply curve are the speed of adjustment of input prices and the degree of information that people possess within a short-run interval. Thus, the short-run aggregate supply curve is more steeply sloped if input prices adjust more rapidly and people become more fully informed within a short-run interval.
11-6. Suppose that there is a temporary, but significant, increase in oil prices in an economy with an upward-sloping SRAS curve. If policymakers wish to prevent the equilibrium price level from changing in response to the oil price increase, should they increase or decrease the quantity of money in circulation? Why?
To prevent a short-run increase in the price level from taking place after the temporary rise in oil prices shifts the SRAS curve leftward, policymakers should decrease the quantity of money in circulation. This will shift the AD curve leftward and prevent the equilibrium price level from rising in the short run.
11-7. As in Problem 11-6, suppose that there is a temporary, but significant, increase in oil prices in an economy with an upward-sloping SRAS curve. In this case, however, suppose that policymakers wish to prevent equilibrium real GDP from changing in response to the oil price increase. Should they increase or decrease the quantity of money in circulation? Why?
To prevent a short-run decrease in real GDP from taking place after the temporary rise in oil prices shifts the SRAS curve leftward, policymakers should increase the quantity of money in circulation. This will shift the AD curve rightward and prevent equilibrium real GDP from declining in the short run.
11-8. Based on your answers to Problems 11-6 and 11-7, can policymakers stabilize both the price level and real GDP simultaneously in response to a short-lived but sudden rise in oil prices? Explain briefly.
In light of the answers to problems 11-6 and 11-7, it is not possible for policymakers to stabilize both the price level and real GDP simultaneously in response to a temporary increase in oil prices. Stabilizing the price level requires reducing the quantity of money, but stabilizing real GDP required increasing the quantity of money.
11-9. 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. Explain, 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. Be sure to discuss the spending gap that the Keynesian model indicates would result in the short run.
An increase in total planned real expenditures by U.S. households in response to an increase in the quantity of money in circulation implies a rightward shift in the position of the aggregate demand curve along the short-run aggregate supply curve. The predicted effects are increases in both the equilibrium U.S. price level and equilibrium U.S. real GDP. Keynesian theory indicates that a consequence would be a short-term inflationary gap between expenditures on real GDP in the short run and expenditures on real GDP that would be consistent with long-run equilibrium.
11-10. Between early 2008 and the beginning of 2009, a gradual stock-market downturn 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. Explain, 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. Be sure to discuss the spending gap that the Keynesian model indicates would result in the short run.
A reduction in total planned real expenditures by most U.S. residents at any given price level implies a leftward shift in the position of the aggregate demand curve along the short-run aggregate supply curve. The predicted effects are decreases in both the equilibrium U.S. price level and equilibrium U.S. Real GDP. Keynesian theory indicates that a consequence would be a short-term recessionary gap between expenditures on real GDP in the short run and expenditures on real GDP that would be consistent with long-run equilibrium.
11-11. For each question that follows, suppose that the economy begins at point A. Identify which of the other points on the diagram—point B, C, D, or E—could represent a new short-run equilibrium after the described events take place and move the economy away from point A. Briefly explain your answers.
a. 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.
b. A major hurricane has caused short-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.
c. A strengthening of the value of this nation’s currency in terms of other countries’ currencies affects both the SRAS curve and the AD curve.
a. E: The union wage boost causes the SRAS curve to shift leftward, from SRAS1 to SRAS3.
The reduction in incomes abroad causes import spending in this nation to fall, which induces a leftward shift in the AD curve, from AD1 to AD3.
b. B: The short-term reduction in production capabilities causes the SRAS curve to shift leftward, from SRAS1 to SRAS3, and the increase in money supply growth generates a rightward shift in the AD curve, from AD1 to AD2.
c. C: The strengthening of the value of this nation’s currency reduces the prices of imported inputs that domestic firms utilize to produce goods and services, which causes the SRAS curve to shift rightward, from SRAS1 to SRAS2. At the same time, currency strengthening raises the prices of exports and reduces the prices of imports, so net export spending declines, thereby inducing a leftward shift in the AD curve, from AD1 to AD3.
11-12. Consider an open economy in which the aggregate supply curve slopes upward in the short run. Firms in this nation do not import raw materials or any other productive inputs from abroad, but foreign residents purchase many of the nation’s goods and services. What is the most likely short-run effect on this nation’s economy if there is a significant downturn in economic activity in other nations around the world?
Domestic producers purchase few imported inputs, so the effect on the short-run aggregate supply curve will be minimal. Because foreign residents are key consumers of domestically produced goods, however, the fall in foreign incomes will depress aggregate demand. The equilibrium price level will decline, and equilibrium real GDP will decrease.
11-13. In Figure 11-2, if planned saving was less than planned investment, what would be true of the interest rate in relation to its equilibrium value? How would the interest rate adjust?
Desired saving is below desired investment if the interest rate is below its equilibrium value. Businesses that wish to undertake investment in excess of the amount of saving must offer a higher interest rate to induce an increase in household saving. As the interest rate rises, planned saving will rise, and planned investment will fall. Ultimately, the two are equalized at a 5 percent interest rate.
11-14. Consider Figure 11-3. Will all people who desire to work be employed if the current wage rate is $28 per hour? How many people will be employed and unemployed at this wage rate?
At the $28-per-hour wage rate, the quantity of labor demanded by firms is 150 million, so
150 million people are employed. The quantity of labor supplied by people who wish to work
at this wage rate is 170 million. Consequently, 20 million people will be unemployed at the hourly wage rate of $28.
11-15. Take a look at Figure 11-4. If the Federal Reserve increase the quantity of money in circulation sufficiently to generate a rightward shift in the aggregate demand curve by
$0.5 trillion, will actual equilibrium real GDP rise by this amount in the classical model? Explain.
The $0.5 trillion amount of the rightward shift in the aggregate demand curve is equal to an additional amount of planned spending following the increase in the money supply at the initial equilibrium price level of 111. In the classical model, however, wages and prices adjust rapidly. As a consequence, the equilibrium price level rises to 120, and equilibrium real GDP remains at $18 trillion.
11-16. Consider Figure 11-9. 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.
The decline in economic conditions abroad causes foreign residents to reduce their purchases of domestically produced exports, so total planned expenditures in this nation decrease. Consequently, the aggregate demand curve shifts leftward along the short-run aggregate supply curve, and in the short run, equilibrium real GDP falls below its long-run equilibrium level. A recessionary gap results.
11-17. Consider Figure 11-10. Suppose that the real interest rate suddenly declines for reasons that have nothing to do with the value of the price level. 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.
The decline in the real interest rate induces the nation’s businesses and consumers to increase their total planned expenditures. As a consequence, the aggregate demand curve shifts rightward along the short-run aggregate supply curve, and in the short run, equilibrium real GDP rises above its long-run equilibrium level. An inflationary gap results.
11-18. Take a look at Figure 11-11. If this country’s government decides to enact short-term barriers to international trade and substantial regulations of domestic businesses,
what happens to the short-run equilibrium price level, and why? Is this an example
of demand-pull or cost-push inflation? Explain.
Erecting near-term barriers to international trade and toughened domestic business regulations causes the short-run aggregate supply curve to shift leftward, which pushes up the equilibrium price level in the short run. This government action pushed up businesses’ costs and generated a reduction of short-run aggregate supply that pushed up the price level, so this is an example of cost-push inflation.
Selected References
Cochran, James L., Macroeconomics Before Keynes, Glenview, IL: Scott, Foresman and
Company, 1970.
Davidson, Paul and Eugene Smolensky, Aggregate Supply and Demand Analysis, New York:
Harper & Row, 1964.
Friedman, Milton, A Theory of the Consumption Function, New York: National Bureau of Economic Research, 1957.
Gordon, Robert J., Macroeconomics, 4th ed., Boston: Little, Brown and Company, 1987.
Keynes, John M., The General Theory of Employment, Interest, and Money, New York:
Harcourt Brace, 1964.
Miller, Roger LeRoy and Robert Pulsinelli, Macroeconomics, New York: Harper & Row, 1986.
