Questions for Week 4 Flashcards
(15 cards)
Why is unemployment counter-cyclical?
Unemployment increases during economic downturns as output and demand decrease. It declines during expansions, aligning inversely with the business cycle.
What is the Keynesian view of consumption?
Keynesian theory posits that consumption depends on disposable income, with people spending a portion of their income and saving the rest.
A limitation is its simplicity, as it doesn’t account for wealth, expectations, or borrowing constraints.
What is the purpose of the 45-degree line in the Keynesian model?
The 45-degree line in the income-expenditure diagram represents points where aggregate expenditure equals output, helping to determine equilibrium income visually.
What is planned aggregate expenditure (PAE)?
PAE is the total planned spending in an economy, including consumption (C), planned investment (I_p), government spending (G), and net exports (NX).
What is the Keynesian multiplier, and what affects its size?
The multiplier measures how much output changes in response to an initial change in autonomous spending. A higher marginal propensity to consume (MPC) increases the multiplier, while higher taxes or imports reduce it.
What does Okun’s Law state, and how is it used?
Okun’s Law shows the relationship between output gaps and unemployment. It states that for every 1% increase in unemployment, output falls by β percentage points, with β often set between 1.5-2.0.
Given real GDP of 7840, potential GDP of 8000, and β=1.8, calculate natural unemployment in 2012.
Output gap = (7840−8000)/8000 × 100 = −2%. Using Okun’s Law: −2 = −1.8(U−6) ⇒ U = 4.89%.
What are key assumptions of the Keynesian model?
Firms meet demand at pre-set prices. Short-run fluctuations in demand affect output directly. Prices are sticky, and changes in spending lead to changes in output rather than price adjustments.
For potential GDP of 9000 and actual output of 8500 with β=1.6, what is the actual unemployment rate if the natural rate is 4%?
Output gap = (8500−9000)/9000 × 100 = −5.6%. Using Okun’s Law: −5.6 = −1.6(U−4) ⇒ U = 6.8%.
Given before-tax income, taxes, and consumption data for the Simpson family, how would you find their marginal propensity to consume (MPC)?
Graph the relationship between after-tax income and consumption. MPC = ΔC/Δ(Y−T), where C is consumption, Y is income, and T is taxes.
How does winning a lottery prize impact the Simpsons’ consumption function?
The lottery increases autonomous consumption, shifting the consumption function upward. The MPC remains unchanged, as the increase doesn’t depend on regular income.
For an economy where C=1800+0.6(Y−T), I_p=900, G=1500, NX=100, and T=1500, find the equilibrium output (Y).
Aggregate expenditure (PAE) = 3400 + 0.6Y. Set Y = PAE: Y = 3400 + 0.6Y ⇒ Y = 8500.
If NX increases from 0 to 100, how does it affect short-run equilibrium output in an economy with a multiplier of 5?
With a multiplier of 5, an increase in NX by 100 raises equilibrium output by 5 × 100 = 500.
How would a decrease in NX to -100 affect output in this economy?
A decrease in NX by 100 reduces equilibrium output by 5 × −100 = −500.
How does international trade affect domestic economic cycles?
Changes in foreign demand for exports can amplify domestic cycles.
For example, an increase in exports during foreign economic expansions raises domestic output, while a decline in exports during foreign recessions lowers domestic output.
