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Questions and Answers
What does the equation $P_{t+1} = P_t [1 + \lambda (Y^* - Y)]$ represent?
What does the equation $P_{t+1} = P_t [1 + \lambda (Y^* - Y)]$ represent?
In the case of a recessionary gap, which of the following statements is true?
In the case of a recessionary gap, which of the following statements is true?
What is the nature of the relationship described by the Phillips Curve?
What is the nature of the relationship described by the Phillips Curve?
Which of the following scenarios describes the conditions of an inflationary gap?
Which of the following scenarios describes the conditions of an inflationary gap?
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What does the term $u^$ refer to in the equation $\pi_t = \pi_E + \epsilon(u^ - u)$?
What does the term $u^$ refer to in the equation $\pi_t = \pi_E + \epsilon(u^ - u)$?
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What is the primary reason for price stickiness in the short run?
What is the primary reason for price stickiness in the short run?
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Which factors directly influence shifts in aggregate supply?
Which factors directly influence shifts in aggregate supply?
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What occurs at the intersection of the aggregate demand and short-run aggregate supply curves?
What occurs at the intersection of the aggregate demand and short-run aggregate supply curves?
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What can lead to a rightward shift in the aggregate supply curve?
What can lead to a rightward shift in the aggregate supply curve?
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Which of the following explains why nominal prices adjust slowly to demand shifts?
Which of the following explains why nominal prices adjust slowly to demand shifts?
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What characteristic do modern economic models suggest about short-run aggregate supply (SRAS) and long-run aggregate supply (LRAS)?
What characteristic do modern economic models suggest about short-run aggregate supply (SRAS) and long-run aggregate supply (LRAS)?
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What role do unions play in wage rigidity?
What role do unions play in wage rigidity?
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Which of the following statements about equilibrium income is true?
Which of the following statements about equilibrium income is true?
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What is the definition of unemployment?
What is the definition of unemployment?
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Which of the following is NOT a reason for a person becoming unemployed?
Which of the following is NOT a reason for a person becoming unemployed?
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What type of unemployment occurs when individuals transition between jobs?
What type of unemployment occurs when individuals transition between jobs?
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How is the unemployment rate calculated?
How is the unemployment rate calculated?
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Which of the following is an example of structural unemployment?
Which of the following is an example of structural unemployment?
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What factor contributes to frictional unemployment?
What factor contributes to frictional unemployment?
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What effect does an increase in the stock of real balances of money have on equilibrium income?
What effect does an increase in the stock of real balances of money have on equilibrium income?
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Which factor makes the AD curve flatter?
Which factor makes the AD curve flatter?
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What is the impact of unemployment as an economic indicator?
What is the impact of unemployment as an economic indicator?
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Which is a common reason for unemployment that leads to a person moving out of the unemployment pool?
Which is a common reason for unemployment that leads to a person moving out of the unemployment pool?
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What does the slope of the AD curve depend on?
What does the slope of the AD curve depend on?
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In which macroeconomic model is output fixed while prices vary based on changes in AD?
In which macroeconomic model is output fixed while prices vary based on changes in AD?
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How does an increase in interest sensitivity of investment (b) affect the AD curve?
How does an increase in interest sensitivity of investment (b) affect the AD curve?
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What is the primary focus of growth theory in macroeconomics?
What is the primary focus of growth theory in macroeconomics?
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What is the primary determinant of future economic well-being according to growth theory?
What is the primary determinant of future economic well-being according to growth theory?
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What characterizes the Short Run Model in macroeconomics?
What characterizes the Short Run Model in macroeconomics?
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What does the IS curve represent in an economy?
What does the IS curve represent in an economy?
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In the LM curve equation, what does the variable M represent?
In the LM curve equation, what does the variable M represent?
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How does an increase in autonomous spending affect the IS curve?
How does an increase in autonomous spending affect the IS curve?
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What is the primary assumption behind the equilibrium of goods and money markets?
What is the primary assumption behind the equilibrium of goods and money markets?
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What happens to interest rates when the LM curve shifts down due to increasing prices?
What happens to interest rates when the LM curve shifts down due to increasing prices?
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Which equation represents the AD schedule derived from the IS and LM curves?
Which equation represents the AD schedule derived from the IS and LM curves?
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How does the AD curve behave based on its equation?
How does the AD curve behave based on its equation?
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What does the variable αG represent in the context of the IS curve?
What does the variable αG represent in the context of the IS curve?
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What occurs when both the IS and LM curves shift simultaneously?
What occurs when both the IS and LM curves shift simultaneously?
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In determining the equilibrium condition, what must be true for the LM curve?
In determining the equilibrium condition, what must be true for the LM curve?
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What does the GDP Deflator measure?
What does the GDP Deflator measure?
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Which price index specifically adjusts for changes in product quality?
Which price index specifically adjusts for changes in product quality?
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What is the main difference between the Laspeyres and Paasche's Index?
What is the main difference between the Laspeyres and Paasche's Index?
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How is the Producer Price Index (PPI) weighted?
How is the Producer Price Index (PPI) weighted?
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Which of the following is NOT a characteristic of Core Inflation?
Which of the following is NOT a characteristic of Core Inflation?
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What does CPI measure?
What does CPI measure?
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How is price data for CPI in India collected?
How is price data for CPI in India collected?
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Which index is primarily used to measure inflation from the perspective of producers?
Which index is primarily used to measure inflation from the perspective of producers?
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Study Notes
IS-LM Model Controversies
- Keynesian position: LM curve is elastic (flat), IS curve is inelastic (steep), fiscal policy is powerful, monetary policy is impotent.
- Monetarist position: LM curve is inelastic (steep), IS curve is elastic (flat), fiscal policy is impotent, monetary policy is powerful.
The IS Curve
- The IS curve (Investment-Savings curve) displays combinations of interest rates and output levels where planned spending equals income.
- The IS curve can be derived using the goods market equilibrium condition: Y = AD = A + c(1-t)Y – bi.
- Solving for Y: Y = a(A – bi), where a = 1/(1 – c(1-t)) is the government multiplier.
The LM Curve
- The LM schedule illustrates all interest rate and income combinations where the money market is in equilibrium.
- The LM curve is derived by combining the demand for real balances and a fixed supply of real balances.
- Money market equilibrium: M/P = kY – hi, which can be solved for the interest rate (i): i = 1/h * M/P – kY
Goods Market and Money Market Equilibrium
- The IS and LM schedules outline the conditions needed for equilibrium in both the goods and money markets.
- Assumptions: constant price level, firms supply whatever amount is demanded at that price.
Changes in Equilibrium Levels of Income and the Interest Rate
- Equilibrium levels of income and interest rate change when the IS or LM curve shift.
- An increase in autonomous spending shifts the IS curve outward.
- The resulting change in Y is smaller than the change in autonomous spending due to the slope of the LM curve.
Deriving the AD Schedule
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The AD schedule maps out the IS-LM equilibrium by holding autonomous spending (A) and nominal money supply (M) constant, while allowing prices (P) to vary.
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If prices increase from P1 to P2, the money supply decreases to M/P2.
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This leads to a decrease in the LM curve from LM1 to LM2.
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Interest rates increase from i1 to i2, and output falls from Y₁ to Y₂.
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A higher price level corresponds to a lower AD.
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The equation for the AD curve is derived by substituting the LM equation into the IS equation: Y = a[A – b(1/h M/P – kY)]. Simplifying this gives: Y = (haA + baM/P)/(h + kba).
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The AD schedule illustrates the relationship between output (Y) and the price level (P) given a constant level of autonomous spending (A) and nominal money supply (M).
Aggregate Demand and Supply
- The intersection of the economy's aggregate demand (AD) and short-run aggregate supply (SRAS) curves determines the short-run equilibrium level of real GDP and price level. The intersection point of AD and long-run aggregate supply (LRAS) determines the long-run equilibrium.
Unemployment and Output
- Unemployment and output are linked but not perfectly correlated. Unemployment is a lagging indicator.
- Unemployment may be defined as a situation where a person is capable of working at the prevailing wage rate but cannot find a job.
- Unemployment rates are calculated by dividing the number of unemployed individuals by the total labour force multiplied by 100.
Types of Unemployment
- Frictional unemployment exists when individuals move between jobs; it's often a temporary state. It arises from the structure of the labor market (search for new/better jobs, mobility of labor).
- Structural unemployment arises from a mismatch between the skills of the workforce and the jobs available in the market (e.g., due to automation or economic restructuring).
- Cyclical unemployment occurs during economic downturns. The presence of cyclical unemployment indicates a downturn in the economy.
- Open unemployment occurs when there are more job seekers than available jobs.
- Disguised unemployment exists when more people are working than are needed.
- Seasonal unemployment occurs in industries where work is time-dependent and only exists during certain times of the year.
- Casual unemployment arises from short-term contracts, raw material shortages, changes in demand, or business ownership changes.
The Wage-Unemployment Relationship and Sticky Wages
- Wages adjust slowly to changes in demand, this phenomenon is known as wage stickiness. In neoclassical theory, wages adjust to ensure full employment output.
- The labor market involves long-term employer-worker relationships, resulting in periodic wage renegotiations that may not happen frequently, due to the costs of doing so.
- When demand for labor increases, wages rise.
- The process of wage and price adjustment will continue until full employment level is reached.
Inflation
- Inflation is the rate of change in the general price level. The formula is: Current price – Past price/Past Price.
- Different modes of inflation include creeping, galloping, hyperinflation, deflation, and stagflation.
Price Indexes
- A price index measures the change in the price level.
- GDP deflator: Ratio of the nominal GDP to real GDP.
- CPI: Measures the cost of buying a representative basket of goods and services and takes into account factors like substitution effect and quality/feature changes.
- PPI: Measures the cost of a fixed basket of goods and services as they enter the production process.
Core Inflation
- Core inflation excludes food and energy prices because their prices fluctuate too much.
Costs of Inflation
- Extremely high inflation has obvious costs, resulting in decreased medium of exchange value.
- Lower, expected inflation results in costs such as shoe-leather costs (holding money to avoid inflation and changing holdings of various forms of money) and menu costs (the costs of adjusting prices or wages).
- Unexpected inflation has distributional costs.
Inflation and Output
- Prices are related with output using the formula: Pt+1 = Pt [1 + (Y* – Y)] Inflation is linked to unemployment:πt=πe+λ(Y0-Y*) u* = Natural rate of unemployment where u = unemployment in the current period.
The Phillips Curve
- The Phillips curve plots the inflation rate against unemployment.
- It suggests a possible trade-off between inflation and unemployment in the short run.
Policy Tradeoff
- The Phillips Curve shows a potential trade-off between wage inflation and unemployment from a policy maker's perspective.
- In reality, the tradeoff is a medium-run phenomenon, not a universal one. The tradeoff will disappear as the AS becomes vertical.
Major Causes of Unemployment in India
- Large population
- Low or no educational levels
- Inadequate state support and poor infrastructure
- High Informal sector with lack of skills
- Restricted growth in infrastructure and investment in some sectors
- Low productivity in agriculture and lack of opportunities
- Regressive social norms
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Description
Explore the complex debates surrounding the IS-LM model, including the contrasting views of Keynesians and Monetarists on the elasticity of the IS and LM curves. Dive into the fundamental equations that define these curves and their implications for fiscal and monetary policy effectiveness.
