Principles of Economics (12th Edition)
12th Edition
ISBN: 9780134078779
Author: Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher: PEARSON
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Chapter 26, Problem 5.5P
To determine
The reason for the
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Students have asked these similar questions
In the Keynesian framework, which of the following events might cause a reaction ?
a) A large increase in the price of the homes people own
b) Rapid growth in the economy of a major trading partner
c) The development of a major new technology offers profitable opportunities for business
d) The interest rate rises
e) The good imported from a major trading partner becomes much less expensive
Select the answer that best describes Keynesian and Classical economic theories.
Classical theory is useful for describing the long-run movement between economic equilibria while Keynesian theory is helpful to describe short-run movements in the price level.
Classical theory suggests that the economy will quickly move between equilibria, eliminating the need for government intervention. Keynesian theory suggests that fiscal and/or monetary policy can be useful in counteracting changes in equilibria resulting from sticky prices and sticky wages.
Keynesian theory suggests that tax cuts or direct government expenditure are ways to stimulate the economy while Classical theory suggests that only tax cuts provide useful stimulus.
Classical and Keynesian theories both advocate for direct government intervention during recessions.
Consider the impact of thriftiness in the Keynesian Cross Model. Suppose the consumption function is
C=C¯+c(Y−T¯)
where C¯ is called autonomous consumption and cc is the marginal propensity to consume.
a) What happens to equilibrium income when society becomes more thrifty (i.e., a decline in C¯)
b) Your answer to (a) is called the Paradox of Thrift. Explain why consuming less (and saving more) is not a good thing in this model. (Hint: a decrease in consumption wouldn’t be so bad in our classical model of Chapter 3 because we assumed national savings equaled investment in the long run.)
Chapter 26 Solutions
Principles of Economics (12th Edition)
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- Q.1.12 Which one of the following statements about the simple Keynesian macroeconomic model is correct? (1) Supply creates its own demand; (2) Equilibrium can occur at any level of income, not only the full- employment level; (3) The model can be used to study inflation; (4) Wages and prices are variable.arrow_forwardSuppose the economy is operating at potential GDP when it experiences an increase in export demand. How might the economy increase production of exports to meet this demand, given that the economy is already at full employment?arrow_forwardExplain why in our New-Keynesian model, equilibrium out- put (Y) and employment (N) are demand-determined. What is the key parameter driving this result? Explain.arrow_forward
- Which of the following describes the use of Keynesian macroeconomic policy to resolve an inflationary gap problem in the economy? a) Unemployment, resulting from the short-run product markets equilibrium being below Long-run Aggregate Supply (LRAS), causes wages to decline, which increases short-run Aggregate Supply (AS), until long-run equilibrium is attained at full employment level of income and a lower price level. b) Government spending is increased, increasing Aggregate Demand (AD) to a level sufficient to attain long-run equilibrium at full employment level of income and a higher price level. c) In attempting to produce beyond the economy's natural level of GDP, producers bid up wages and prices of other resources, causing the short-run Aggregate Supply (AS) to decrease to the point where long-run equilibrium is restored. d) Taxes are increased reducing Aggregate Demand (AD) to a level consistent with full employment.arrow_forwardQUESTION 5Imagine the following simple Keynesian macroeconomic model for a closed economy.TD = C + Ip + G (total demand)C = C0 + YD (aggregate household consumption)YD = Y − T (aggregate household disposable income)Ip = I0 + aY − bR (aggregate planned investment)Y = TD (output, equilibrium condition)BB = T – G (government budget balance)With:G government consumption, T taxes, R real interest rate (exogenous variables)C0) and I0 autonomous consumption and investment0 < a, c, a+c < 1, b > 0 constant parametersDerive the equation for output and answer the following question. If the government in this model simultaneously increases its consumption G and its taxes T by the same amount, then: total demand decreases, and equilibrium output declines. total demand decreases, and equilibrium output declines, but only if C > G. total demand increases, and equilibrium output rises. The rise of output is stronger the higher the households’ marginal propensity to consume. total demand…arrow_forwardIt is found that the consumption function for the economy is C = 50 + 0.8 Y d . Current level of output is 8800 and the potential GDP is 9000. Assuming the Keynesian view of the short run, answer the following questions. Illustrate this economy using a carefully labeled diagram. What is a larger concern for this economy: unemployment or inflation? If the economic policy makers want to bring the level of output to the potential GDP by changing the government expenditures (G), how much do they need to change G? Be sure to indicate whether the change is an increase or decrease. True or False and explain: If the policy in part c was successful, the unemployment rate will be zero.arrow_forward
- Complete the following table by matching the macroeconomic assumptions about aggregate supply to the appropriate school of thought. Assumption Classical Keynesian Only an increase in aggregate demand can move an economy out of a recession and back to potential real GDP quickly. Product prices and wages tend to be inflexible. The following graph shows the aggregate demand (ADAD) and aggregate supply (ASAS) curves for a hypothetical economy that is currently operating below its full-employment output level. That is, the economy is currently in a recession. The aggregate supply curve (ASAS) in this diagram is consistent with the view of aggregate supply. According to this viewpoint, the government should spending in response to the recession. Shift the appropriate curve on the graph to illustrate the impact of this change in government spending. ADASPRICE LEVELREAL GDP (Trillions of dollars)AD AS The prescribed…arrow_forwardA recessionary gap exists when the macro economy is in equilibrium at less than the potential output of the the economy because aggregate demand is insufficient to fully employ all of society' s resources. In other words, the equilibrium (AD = AS) occurs to the left of the vertical long-run supply curve. At this point, potential output is reached ( full employment) and if any unemployment occurs, then it is due to structural or frictional; that is, the economy is at its natural rate of employment. True or falsesarrow_forwardA principle difference between the new Classical and the new Keynesian models has to do with the choices made by business firms. We find that: a)new classical business firms choose the output level given the price level, while new Keynesian firms choose the price level given the level of output. b)new classical business firms choose the price level given the output level, while new Keynesian firms choose the output level given the level of output. c)both new classical and new Keynesian firms select the price level, but only new classical firms select the output level. d)both new classical and new Keynesian firms select the output level, but only Keynesian firms select the price level.arrow_forward
- Recent data from the Bureau of Labor Statistics show that the average price level for consumers rose 5.4% over the past year. While some are expressing concern over rising inflation leading the economy to “overheat,” there is some evidence indicating that this is due to the reopening of the economy as producers adjust to rising demand for goods and services. Many of the goods with the largest price increases, like bacon or cars and trucks, cannot have their production ramped up as quickly as demand is increasing. Other industries are facing supply chain challenges, like shortages of truck drivers. These problems are most likely to be short term, so, as supply catches up with demand, we can expect to see prices return to normal. As evidence, after spiking to record highs in early summer, lumber prices have now fallen below their price at the start of the year. The reason for the dramatic price increase earlier in the year was a combination of reduced supply in 2019 and a surge in demand…arrow_forwardPRICE LEVEL Complete the following table by matching the macroeconomic assumptions about aggregate supply to the appropriate school of thought. Assumption Keynesian Classical Product prices and production costs are flexible. Only an increase in aggregate demand can move an economy out of a recession and back to potential real GDP quickly. The following graph shows the aggregate demand (AD) and aggregate supply (AS) curves for a hypothetical economy that is currently operating below its full-employment output level. That is, the economy is currently in a recession. The aggregate supply curve (AS) in this diagram is consistent with the government should spending in response to the recession. view of aggregate supply. According to this viewpoint, the Shift the appropriate curve on the graph to illustrate the impact of this change in government spending. REAL GDP (Trillions of dollars) AD AD AS AS ?arrow_forwardExplain and show in detail whether the following sentence is correct or incorrect: "For Keynes, the rigidity of the real wage was the fundamental factor to explain the possibility of a capitalist economy operating with a high rate of unemployment".arrow_forward
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