Midterm Intermediate Macroeconomics Essay

1. How are presidential election outcomes related to the performance of the economy? Presidential elections and the economy have a very close relationship and they go together hand and hand. Usually when the economy is good and opinion of the government is positive, the incumbent or the party of the last president wins the election. People tend the lean towards why change a good thing. A couple of theories exist in the relationship of the economy and presidents. The first one is that voters will vote for whichever president they feel shares the same economic vales that they have. Usually the poor vote liberal or for bigger government because they think they will provide more economic relief them and their families. The second theory is that the president currently in power will attempt to pass policies that will allow their party to stay in power. So, presidents on their first term will make monetary and fiscal policies close to the election year to stimulate the economy to sway voters. Two examples of how the economy can sway the presidential election against an incumbent are Hoover and George H.W. Bush. Both presidents had economic downturns during their first term in office and were not reelected. Other factors play key roles in presidential elections, but none are bigger than economics. 2. Discuss the difference between Microeconomics and Macroeconomics. Microeconomics is the study of decision making undertaken by individuals (households) and by business firms. Micro looks at the decisions of individual’s actions, like deciding to work overtime or not. Another example is a small business decision on how much to spend of advertising cost. Micro focuses on the supply and demand in an economy, and how businesses can maximize profits. Macroeconomics is the study of the behavior of the economy as a whole. Macro deals with national items like the unemployment rate, government budget deficit, and money supplied by the FED. Macro deals with aggregates, such as the total output as in the economy. For example, Macro would explore how net exports could affect a nation’s capital. 3. Use the concepts of gross and net investment to distinguish between an economy that has a rising stock of capital and one that has a falling stock of capital. â€Å"In 1933 net private domestic investment was minus $6 billion. This means that in that particular year the economy produced no capital goods at all.† Do you agree? Why or why not? Explain: â€Å"Though net investment can be positive, negative, or zero, it is quite impossible for gross investment to be less than zero.† Gross Investment = Net Investment + Depreciation We can rearrange this to say: Net Investment = Gross Investment – Depreciation The capital stock of an economy rises when net investment is positive, that is when gross investment exceeds depreciation. The capital stock falls when net investment is negative, that is when gross investment is less than depreciation. In 1933 net private domestic investment was minus $6 billion. This does not mean the country produced no capital goods: what it means is that the production of capital goods was less than what was lost due to wear and tear, thus the net impact was an overall loss in capital stock. Gross private investment in most cases cannot be negative, since you can decide not to invest in new factories, but how do you decide to make a negative investment on an economy wide scale. The only possible case I can think of, and many will disagree with this, is when China under Mao went for what is now called the â€Å"Great Leap Forward.† Farmers started melting their ploughs and other equipment to provide steel to the government, thus destroying the existing cap ital, without investing in the new one. Thus you are using your effort to destroy what is there: negative gross investment. 4. What are the major factors that have affected U.S. household consumption since the recession in 2001? Many major events have happened in the country and in the world since the year of 2001. The price of oil has skyrocketed causing more Americans to spend money fueling their cars rather than buying goods and services. We have also encountered another recession in 2007 because of risky trading/investment tactics on Wall Street that caused the housing market to crash. This put unemployment at an all-time high since the depression era, and destroyed faith in America’s economic system. Firms were reluctant to investment in the American public because they were afraid we would lose our jobs. Also, we have fought in two wars. One of the wars has been the longest in American history. This dries up resources and ups government spending. The government has less money to investment its citizens and firms have fewer resources to produce products for consumers to buy. 5. Briefly explain how the following would shift the IS function to the right. a.A change to lump-sum taxation (Specify whether increase or decrease is needed to shift IS curve to the right.) Decreasing a lump sum tax will shift the IS curve to the right. Decreasing the lump sum tax will increase consumer income, which will cause aggregate demand to go up. b.A change to government spending (Specify whether increase or decrease is needed to shift IS curve to the right.) Increasing government spending will shift the IS curve to the right. Increasing government spending will cause aggregate demand to go up, and shift the IS curve to the right. 6. Explain briefly how a change to the following MS, MD, or P (ceteris paribus) would shift the LM function to the right. Include in your discussion whether the variable would have to increase or decrease to cause the rightward LM shift. Discuss which of these the FED exercises control over. a. MS. b. MD (money demand). c. P (price index). The LM curve deals with interest and income and is sloping upward. When the demand of money and supply of money equal each other the market is at equilibrium. The LM curve shifts when either the supply or demand of money changes. The FED has control over money supplied. a. MS. Increasing money supplied would cause the LM curve to shift to the right. Money supplied would drop interest rates and shift the IS curve to right. b. MD. An increase in money demand would cause the LM curve to shift to the right. Consumers are wanting to spend more which raises GDP c. P. Price is the only one out of the three that a decrease is needed to shift the IS curve to the right. When prices go down wages go down and consumers have less to spend. 7. By how much will GDP change if firms increase their investment by $8 billion and the MPC is .80? If the MPC is .67? MPC .80 = 40 billion. The MPC produces a multiplier of 5. (1/(1-.8))=5. 5Ãâ€"8=40 billion MPC .67 = 24 billion. The MPC produces a multiplier of 3.03030. (1/(1-.67))=3.0303. 3.0303Ãâ€"8= 24.2424 billion 8. Suppose that private sector spending is highly sensitive to a change in interest rate. Compare the effectiveness of monetary and fiscal policy in terms of rising and lowering real GDP. A reduction in the national interest rate will increase the GDP because investments will be in a higher demand. If the FED raises interest rates then investments will go down and lower GDP. If the Fed keeps interest rates low like they have the last couple of years in an attempt to stimulate the economy, GDP should go up. 9. Assume that a hypothetical economy with an MPC of .8 is experiencing severe recession. By how much would government spending have to increase to shift the aggregate demand curve rightward by $25 billion? How large a tax cut would be needed to achieve this same increase in aggregate demand? Why the difference? Determine one possible combination of government spending increases and tax decreases that would accomplish this same goal. The MPC is the same as Question 7 so we know that it will give us a spending multiplier of 5. The tax cut multiplier is .8/(1-.8)=4. If we want to shift the aggregate demand curve by 25 billion, you would divide the 25 billion wanted by the multiplier of 5. 25/5= 5 billion. Same formula goes to the tax cut but with a multiplier of 4. 25/4= 6.25. Either way you are trying to put money into consumers’ pockets so they will hopefully spend more. The difference is because of the MPC. Only .8 of the tax cut will be spend by consumers. They will save the other .2. A possible combo is an increase of 1 billion in government spending and a 5 billion dollar tax cut. 10. What are government’s fiscal policy options for ending severe demand-pull inflation? Use the aggregate demand-aggregate supply model to show the impact of these policies on the price level. Which of these fiscal policy options do you think might be favored by a person who wants to preserve the size of government? A person who thinks the public sector is too large. There are several things the government can do. They can reduce government spending or increase taxes; both ways will put money back into the government’s pocket. Either way the key is putting money back into the government’s pocket. The price level will fall when it is flexible downward. The overall goal of government policy is to provide stability and not have price levels raise slowly not rapidly. Also, the do not want to reduce price levels. Democrats want to preserve the size of government. They favor more taxes and more government spending. GOP favors fewer taxes, reducing government spending, and reducing government power over the citizens. 11. Explain why relatively flat as opposite relatively steep labor demand curves are more consistent with the empirical observation that there are relatively minor changes in the real wage rate over the course of the business cycle. If the demand curve is flat then a reduction or an increment in labor demand does not alter the price (the wage is too much). On the other hand, if the demand curve is steep, then an equivalent change in demand has much bigger change in the wage rates. Empirical results suggest that wages are sticky, and the steep labor demand curve cannot explain this observation. 12. Is sustainable long-run equilibrium always reached when the AD and SAS curves intersect? Why or why not? No. The economy would be in a short-run equilibrium when the AD and SAS curves intersect, and not necessarily in long-run equilibrium. It would be in a sustainable long-run equilibrium if the economy finds itself operating on both the labor demand curve and the labor supply curve. This occurs when the labor demand and labor supply curves intersect, so there is no pressure to change. At this point the actual real wage equals the equilibrium real wage and Y = YN. At any other combination of W, P, and Y, the SAS curve will shift as expectations are adjusted. 13. If the equilibrium real wage remains constant, what happens to the nominal wage when the actual inflation rate exceeds the expected inflation rate? Real Wage Rate = Nominal Wage Rate – Inflation. Taking expectations we can say that expected Real Wage Rate = Expected Nominal Wage Rate – Expected Inflation This can be rewritten as expected Real Wage Rate + Expected Inflation = Expected Nominal Wage Rate. If the equilibrium real wage rate remains constant, while inflation exceeds expected inflation then the nominal wage rate has to rise. 14. â€Å"In the steady state, the government benefits from inflation.† Explain. The government benefits from inflation in two ways. First, it obtains an extra source of revenue, called seignorage or the inflation tax. The government can then lower ordinary taxes or increase spending more than it could otherwise. Second, the government may gain if inflation raises the nominal interest rate by less than inflation itself.