Macroeconomics Final Exam Study Guide – Fall 2007

Seventy-five percent of your exam will come directly off the list of eight questions that follow. Stay tuned for any edits.

1. Explain the trade-off in the Keynesian model.

2. a. Graph the AD/AS model of the economy and label the equilibrium 1.

b. Redraw (a). Show how the oil price increases of the 1970s are reflected in this model. Label the new equilibrium 2. (See pages 98 and 102 for a discussion.)

c. In words, what were the effects of the oil price increases?

d. Redraw (b). Illustrate one Keynesian response to stagflation and label the new equilibrium 3.

e. In words, what are the consequences of this policy?

f. Redraw (b). Illustrate the other Keynesian response to stagflation and label the new equilibrium 4.

g. In words, what are the consequences of this policy?

3. Illustrate with a Keynesian cross an economy operating at its potential.

4. a. Use a Keynesian cross to illustrate an economy with a level of GDP below potential output.

b. In Keynesian terms, list and explain what may have caused this performance, other than fiscal or monetary policies.

c. Explain the appropriate fiscal policy responses according to the Keynesians.

d. Name and define the three tools of the Fed and explain how each will be used in response to output being below the potential level.

e. Explain the impact of the monetary policy that you just recommended.

5. Repeat the previous question for an economy operating above potential output.

6. Explain how the multiplier works using numbers and either the circular flow or the chart. Illustrate, assuming the MPC is .8 (or .9 or .75 or .5) and that autonomous investment increases (or decreases) by $10 billion (or $20 or $50 or $80). In each case, by how much does equilibrium GDP change? Illustrate with a Keynesian cross.

7. Based on Affluenza, critique the macroeconomic goal of increasing GDP. (Include chapter themes from Part I of the book, and the discussion in chapter 29; prepare a two-paragraph answer.)

8. Contrast “consumer sovereignty” with “producer sovereignty.” Discuss in the context of the fashion industry and the personal transportation industry. Explain how this distinction affects the “what to produce?” question. How does it affect the answer to the question, “who does the economy serve?”

The remainder of the exam will be based on the following study questions:

1. What is the name of Adam Smith’s book, and what year was it published?

2. Four major foci of macroeconomics?

3. What has been the average annual growth in GDP in the US since 1930? What four factors do mainstream economists point to as the major contributors to long-term growth in GDP? Provide an example of each. Name two essential factors that economists often take for granted that are key to the economy’s performance.

4. Define “potential output” and relate is to the previous question.

5. What determines a nation’s capacity to produce? What determines the production level in the short run?

6. Graph the aggregate demand and aggregate supply model. Why is AD downward sloping? (The one reason we reviewed in class is sufficient.) What is held constant along the AS curve? Use the model to illustrate stagflation. According to McEachern, what two factors caused our stagflation?

7. Construct the Keynesian cross and explain the 45 degree line. What output level will result? Explain the adjustment process from above and below that output level, including the role that inventories play.

8. How might it be undesirable to be at the equilibrium?

9. According to Keynes, why was output so low during the 1930s? What solution did he promote? Illustrate with the Keynesian cross.

over

10. What makes the size of the multiplier larger? Explain or illustrate.

11. Distinguish between the deficit and the debt. What is the approximate size of each currently? Is the debt “large”? How does Exhibit 5 on page 360 relate to that question? Also related to that Exhibit 5: Who is included in “the public”? Besides the public, who holds the debt?

Page 361: In what way is the debt NOT a burden on future generations?

12. Provide three circumstances under which many economists find deficits desirable. Explain the major problem with deficits. Explain the major arguments against the debt. What percent of the privately held debt do foreigners hold? (See page 382.)

13. Is the social security program currently in surplus or deficit? Explain two ways how the retirement of the boomers is going to be a burden on future taxpayers. Explain three proposals to change social security so that it can meet its retirement obligations to the boomers.

14. What are the three functions of money?

Define monetary policy, fiscal policy, M1, and central bank.

Name the US central bank. Is it public or private? Explain. What about it makes it independent? Argue for and against this independence. Who is the current chair of this bank?

15. What constitutes banks’ reserves? Who creates money, i.e., increases the size of the money supply?

Graph money supply and money demand, and show the effect of increasing and decreasing the size of the money supply.

16. Name and define the Fed’s three tools to affect the size of the money supply.

How do changes in interest rates impact the economy?

17. Related to fiscal and monetary policy: See page 330 to learn about the four “lags” that hamper the effectiveness of stabilization policy. Provide an explanation and/or illustrations of each.

18. Distinguish between “absolute advantage” and “comparative advantage.”

State the “law of comparative advantage” and its implications

Assume the following:

Output per worker per hour

Baseballs Footballs

Jamaica 3 3

UK 2 1

Which nation has the absolute advantage in producing baseballs? Explain.

Which nation has the comparative advantage in producing baseballs? Explain.

If the nations engaged in trade, which would export baseballs?

19. Name the economist who is most closely associated with comparative advantage.

20. Explain the assumptions upon which the law of comparative advantage is based. What happens if those assumptions are not met?

21. What are the main forms that protectionism has traditionally taken? What new types of "protectionism" are being debated today?

22. What does WTO stand for? Who are its members? What is its purpose? According to Nobel laureate Joseph Stiglitz, who has benefited most from the multilateral trade deals?

23. What is meant by “trade deficit”? What size is the recent monthly US trade deficit? How is this considered to be a problem?