Economics Principles, Problems, and Policies

Campbell R. McConnell, Stanley L. Brue, Sean M. Flynn

Chapter 36

Current Issues in Macro Theory and Policy - all with Video Answers

Educators

Chapter Questions

Problem 1

The mainstream view of macroeconomic instability emphasizes sticky prices. To answer the following questions, modify the aggregate supply curve in the extended AD-AS model introduced in Chapter $35 .$ First, imagine that both input and output prices are fixed. What does the aggregate supply curve look like? If AD decreases in this situation, what will happen to equilibrium output and the price level? Next, imagine that input prices are fixed, but output prices are flexible. What does the aggregate supply curve look like? In this case, if AD decreases, what will happen to equilibrium output and the price level? Finally, if both input and output prices are fully flexible, what does the aggregate supply curve look like? In this case, if AD decreases, what will happen to equilibrium output and the price level? (Hint: If you are having trouble drawing these three aggregate supply curves, review the immediate-short-run aggregate supply curve and the short-run aggregate supply curve introduced in Chapter 29 as well as the long-run aggregate supply curve introduced in Chapter $35 .$ )

Pragya Ahuja

Pragya Ahuja

Numerade Educator

Problem 2

According to mainstream economists, what is the usual cause of macroeconomic instability? What role does the spending-income multiplier play in creating instability? How might adverse aggregate supply factors cause instability, according to mainstream economists?

Pragya Ahuja

Numerade Educator

Problem 3

State and explain the basic equation of monetarism. What is the major cause of macroeconomic instability, as viewed by monetarists? LO2

Pragya Ahuja

Numerade Educator

Problem 4

Suppose that the money supply and the nominal GDP for a hypothetical economy are $\$ 96$ billion and $\$ 336$ billion, respectively. What is the velocity of money? How will households and businesses react if the central bank reduces the money supply by $\$ 20$ billion? By how much will nominal GDP have to fall to restore equilibrium, according to the monetarist perspective?

Pragya Ahuja

Numerade Educator

Problem 5

Briefly describe the difference between a so-called real business cycle and a more traditional "spending" business cycle.

Pragya Ahuja

Numerade Educator

Problem 6

Craig and Kris were walking directly toward each other in a congested store aisle. Craig moved to his left to avoid Kris, and at the same time Kris moved to his right to avoid Craig. They bumped into each other. What concept does this example illustrate? How does this idea relate to macroeconomic instability?

Pragya Ahuja

Numerade Educator

Problem 7

KEY QUESTION Use an AD-AS graph to demonstrate and explain the price-level and real-output outcome of an anticipated decline in aggregate demand, as viewed by RET economists. (Assume that the economy initially is operating at its full-employment level of output.) Then demonstrate and explain on the same graph the outcome as viewed by mainstream economists. LO1

Pragya Ahuja

Numerade Educator

Problem 8

What is an efficiency wage? How might payment of an above-market wage reduce shirking by employees and reduce worker turnover? How might efficiency wages contribute to downward wage inflexibility, at least for a time, when aggregate demand declines? LO1

Pragya Ahuja

Numerade Educator

Problem 9

How might relationships between so-called insiders and outsiders contribute to downward wage inflexibility?

Pragya Ahuja

Numerade Educator

Problem 10

Use the equation of exchange to explain the rationale for a monetary rule. Why will such a rule run into trouble if $V$ unexpectedly falls because of, say, a drop in investment spending by businesses? LO2

Pragya Ahuja

Numerade Educator

Problem 11

Answer parts $a$ and $b,$ below, on the basis of the following information for a hypothetical economy in year 1 : money supply $=\$ 400$ billion; long-term annual growth of potential $\mathrm{GDP}=3$ percent; velocity $=4 .$ Assume that the banking system initially has no excess reserves and that the reserve requirement is 10 percent. Also assume that velocity is constant and that the economy initially is operating at its fullemployment real output.
a. What is the level of nominal GDP in year 1 ?
b. Suppose the Fed adheres to a monetary rule through open-market operations. What amount of U.S. securities will it have to sell to, or buy from, banks or the public between years 1 and 2 to meet its monetary rule?

Pragya Ahuja

Numerade Educator

Problem 12

Explain the difference between "active" discretionary fiscal policy advocated by mainstream economists and "passive" fiscal policy advocated by new classical economists. Explain: "The problem with a balanced-budget amendment is that it would, in a sense, require active fiscal policy-but in the wrong direction-as the economy slides into recession."

Oluwadamilola Ameobi

Oluwadamilola Ameobi

Numerade Educator

Problem 13

Place "MON," "RET," or "MAIN" beside the statements that most closely reflect monetarist, rational expectations, or mainstream views, respectively:
a. Anticipated changes in aggregate demand affect only the price level; they have no effect on real output.
b. Downward wage inflexibility means that declines in aggregate demand can cause long-lasting recession.
c. Changes in the money supply $M$ increase $P Q ;$ at first only $Q$ rises because nominal wages are fixed, but once workers adapt their expectations to new realities, $P$ rises and $Q$ returns to its former level.
d. Fiscal and monetary policies smooth out the business cycle.
e. The Fed should increase the money supply at a fixed annual rate.

Pragya Ahuja

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Problem 14

You have just been elected president of the United States, and the present chairperson of the Federal Reserve Board has resigned. You need to appoint a new person to this position, as well as a person to chair your Council of Economic Advisers. Using Table 36.1 and your knowledge of macroeconomics, identify the views on macro theory and policy you would want your appointees to hold. Remember, the economic health of the entire nation - and your chances for reelection - may depend on your selections.

Majid Borumand

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Problem 15

Compare and contrast the Taylor rule for monetary policy with the older, simpler monetary rule advocated by Milton Friedman.

Pragya Ahuja

Numerade Educator