ECON 205 2nd Edition Lecture 22 Outline of Last Lecture I Aggregate Supply Short and Long Term II Determinants of Aggregate Supply III Sticky Wages and Prices IV Unemployment Costs V Inflexibility and Menu Costs Outline of Current Lecture I Review of the Fiscal Clif II New Classical and Supply Side Economics III Keynes Macroeconomics IV GDP Growth and Inflation V Currency Overvaluation and the Trade Deficit VI Practice Questions Current Lecture I Review of the Fiscal Clif The 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 Economics Robert 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 Macroeconomics John 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 Inflation In 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 less than two years while depressions last longer V Currency Overvaluation and the Trade Deficit An 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 Questions High capital mobility occurs when there is A Easy flow of financial capital B Low regulatory barriers C Unregulated exchange D All of the above The answer is A and B Question Which of the following are central themes of macroeconomics A Short term fluctuations in employment financial conditions and prices B Long term trends in output employment and prices C 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 Smith B Schumpeter C Ben Bernanke The answer is none of the above The answer should always be John Maynard Keynes What are the goals of macroeconomics A Growing GDP B Stable employment C Low inflation D All of the above The answer is D all of the above Which of the following is not a fiscal policy A Government purchases of goods and services B Transfer payments C Government welfare D Stocks and bonds selling D 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 rates B Aggregate demand and supply diferences C Potential and actual GDP D Nominal and actual GDP E Fiscal and monetary policy The 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 unemployment B Price stability C High Value of the Euro D High growth rate of the members The answer is B as the Europeans are very concerned about hyperinflation Their monetary policy is directed at inflation rather than unemployment