Principles of Macroeconomics
Review Guideline (Chapter 8-11)
Chapter 8.
1. Aggregate Demand
definition
why downward sloping (interest rate defect, wealth effect, and international trade effect)
2. Aggregate Supply
definition
In the long run, AS is vertical (classical theory)
In the short run, AS is very flat (Keynesian theory)
Modern theory – (a) if there is huge unemployment - flat,
(b) if is in bottle neck - upward,
(c) if it is at full employment – vertical.
Potential GDP, actual real GDP (i.e. equilibrium real GDP) and GDP gap.
3. Changes in AD
4. Changes in AS
5. AD-AS diagrams that related to recession, overheating, stagflation, steady growth and full employment.
*Selected answers of Questions on page 173.
#5. Natural rate of unemployment. In the U.S. it is about 5%.
#6. a. Q1. b. P1. c. P2, P3 respectively.
Chapter 9.
1. Fiscal policies – concept, how they affect AD, expansionary (contractionary) fiscal policy.
2. The multiplier effect
Marginal propensity to consume
Spending multiplier and how much it would change AD (or real GDP)
Tax multiplier and how much it would change AD (or real GDP)
3. Budget deficit, budget surplus, balanced budget and what Keynes suggests.
4. Record of U.S. government budget.
*Selected answers of Questions on page 193.
#5. Spending multiplier is 2. Tax multiplier is -1. Increase government spending of $100 million will cause aggregate spending to increase by $200 million. Cutting tax of $50 million will cause aggregate spending to increase by $50 million.
#6.
Suggestion (a) - Increase government spending by $40 billion only;
Suggestion (b) - Cut tax by about $66.67 billion only; or
Suggestion (c) – do both (increase G and cut T). You can generate varies of combinations. For example, increase G by $20 billion and cut tax by $33.33 billion.
Chapter 10.
1. Concepts (barter, specialization, double coincidence of wants, money)
2. Functions of money.
3. Commodity money, Gold Standard, and fiat money.
4. Money supply – M1 and M2.
5. Goldsmith banking – safe keeping – check – balance sheets – fractional reserve banking.
6. Money creation (reserve ratio, money multiplier)
*Selected answers of Questions on page 211.
#2. M1 increased but M2 unchanged.
#3. 20.
#4. Increased by $20,000.
#5. Decreased by $20,000.
Chapter 11.
1. Central Bank. The Federal Reserve Bank of the U.S.
2. Money demand (MD increases if price level increases or income level increases, vice versa).
3. Money supply (controlled by the Fed. MS is changed by the following -
Open Market Operation
Discount rate
Reserve ratio )
4. Monetary policy (both expansionary and contractionary) and how they work.
5. Which monetary policy should be applied to recession, overheating, and steady growth (full employment)?
*Selected answers of Questions on page 223.
#2. $5 million. The interest rate would decrease.
#3. Buying government bonds in the open market; lower the discount rate; and lower the reserve ratio.
#4. In recession the Fed can use expansionary monetary policy including buying government bonds in the open market; lower the discount rate; and/or lower the reserve ratio. This will increase money supply, lower the interest rate, increase investment, increase aggregate demand, and thus increase real GDP and lower unemployment.
In overheating situation, the Fed can use contractionary monetary policy including selling government bonds in the open market; raise the discount rate; and/or raise the reserve ratio. This will decrease money supply, raise the interest rate, lower investment, cool down aggregate demand, and thus subside inflation.