ECON 205 2nd Edition Lecture 22Outline of Last Lecture I. Aggregate Supply, Short and Long TermII. Determinants of Aggregate SupplyIII. Sticky Wages and PricesIV. Unemployment CostsV. Inflexibility and Menu CostsOutline of Current LectureI. Review of the Fiscal ClifII. New Classical and Supply Side EconomicsIII. Keynes’ MacroeconomicsIV. GDP Growth and InflationV. Currency Overvaluation and the Trade DeficitVI. Practice QuestionsCurrent LectureI. Review of the Fiscal ClifThe fiscal clif as described by both parties is inaccurate. The true way to solve the budget crisis is to sponsor economic growth, leading to higher employment, higher tax revenue, and a budget surplus. Cutting programs isn’t truly the answer, but a few programs can be cut due to bureaucratic waste.The “twin gap” was the trade gap, that our net exports were negative, and the fiscal policy gap (we had more expenditures than income). Today, we are wrestling with the fiscal clif instead. Rationale expectation is that future expenditures will be afected by one’s expectation of about future income, family size, and housing prices.II. New Classical and Supply Side EconomicsRobert Lucas, Thomas Sargent, and Robert Barrow sponsor new classical economics. If the government taxes more and spends more, the government competes with the private sector and will make it inefficient. However, studies have shown that the government can be as successful and productive as the private sector. Life cycle model of consumption—consumption decision is influenced by concern for future generation welfare.Supply side economics is an economic theory that says economic growth can be stimulated by lowering barriers (i.e. taxes) to growth for producers. It is embodied by the Laffer Curve.III. Keynes’ MacroeconomicsJohn Maynard Keynes is considered the father of macroeconomics. In 1936 he published his pivotal book explaining that aggregate demand is the key factor in having a healthy economy with optimal employment.The factors behind aggregate demand are consumption, investment, and net exports. If those three factors do not create full employment, the government should make up the diference by deficit financing. He was the first to assign a major role to the government in economic regulation. Output, stable prices, and full employment are the main goals of macroeconomics.The tool to bring about those three goals is fiscal and monetary policy. The government is supposed to regulate the economy and break up monopolies. However, the government allows natural monopolies like utilities for best efficiency. To promote fair pricing, the government sets price ranges. IV. GDP Growth and InflationIn the long run, GDP grows steadily (secular). However, in the short run, growth is cyclic. Stagflation is the concurrence of high unemployment and high inflation. Price stability, the inverse of inflation, means that the consumer price index, a basket measurement of common goods, holds steady over time. Recession is high unemployment and low inflation lasting for lessthan two years, while depressions last longer.V. Currency Overvaluation and the Trade DeficitAn overvalued currency is a currency that is high relative to other currencies. A trade deficit can be caused by a strong overvaluation of the dollar, as people will not buy exports due to expense,recession abroad, and subsequent recession in the United States.Intangible capital refers to education and other forms of human capital.VI. Practice QuestionsHigh capital mobility occurs when there is:A. Easy flow of financial capitalB. Low regulatory barriersC. Unregulated exchangeD. All of the aboveThe answer is A and B. Question: Which of the following are central themes of macroeconomics?A. Short term fluctuations in employment, financial conditions, and pricesB. Long term trends in output, employment, and pricesC. Individual market models of prices and quantities.Macroeconomics is concerned with short-term fluctuations and long-term trends. The answer therefore would be both A and B. C is microeconomics. Who is responsible for the major breakthroughs in macroeconomics?A. Adam SmithB. SchumpeterC. Ben BernankeThe answer is none of the above. The answer should always be John Maynard Keynes.What are the goals of macroeconomics?A. Growing GDPB. Stable employmentC. Low inflationD. All of the aboveThe answer is D, all of the above. Which of the following is not a fiscal policy?A. Government purchases of goods and servicesB. Transfer paymentsC. Government welfareD. Stocks and bonds sellingD as it is monetary policy. Monetary policy is enacted by the Federal Reserve.The GDP gap is measured by the difference between:A. The inflation and unemployment ratesB. Aggregate demand and supply diferencesC. Potential and actual GDPD. Nominal and actual GDPE. Fiscal and monetary policyThe answer is C. If the government finds that the GDP gap is negative, the government should take countercyclical measures: spend more money and cut taxes.The primary objective of the European Central Bank is:A. Low unemploymentB. Price stabilityC. High Value of the EuroD. High growth rate of the membersThe answer is B, as the Europeans are very concerned about hyperinflation. Their monetary policy is directed at inflation rather than