Questions and Answers
What is the term used to describe the collapse of production, employment, and prices in the industrial world in the 1930s?
Who is considered the founder of macroeconomics?
How many economic schools of thought are identified by John Pape?
What is the central belief in free market economics regarding human motivation?
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What is the term used to describe the economic school of thought that emphasizes the role of government intervention in the economy?
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What is the primary goal of free market economics?
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What is the term used to describe the economic school of thought that emphasizes the role of class struggle in shaping economic outcomes?
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What is the term used to describe the economic school of thought that emphasizes the importance of individual freedom and limited government intervention?
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What is the main argument of free marketers against high taxes?
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What do free marketers believe is the major obstacle to the success of their economic model?
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What type of economic system do free marketers support?
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Which of the following is NOT a characteristic of a free market economy?
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What do Marxist economists believe should drive an economy?
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What type of economic system do Marxist economists support?
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Which of the following is a characteristic of a socialist economic system?
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Which economist is associated with the development of Marxist economics?
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Which country has liberalized its economy dramatically, despite being ruled by a communist government?
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What is the main difference between free market and Marxist economics?
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Which economic programme has Vietnam instituted to revive its economy?
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What was the main issue with the global economy in the late 1920s?
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What did Keynes argue was the root of the economic problem?
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What is the focus of Keynesian economics?
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According to classical economic theory, what will happen if there is too much labour and not enough demand for it?
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What is the difference between nominal and real wages?
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Why did Keynes argue that nominal wage cuts would be difficult to implement?
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What is the name of the law that classical economists believed would always be enforced by price adjustments?
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What would happen to consumer demand if nominal wages fell more than prices?
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What was one of the criticisms of Keynes' theory?
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What happens when investment falls, perhaps due to falling consumer demand, over-investment in earlier years, or pessimistic business expectations, and saving does not immediately fall in step?
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According to Keynes, what determines interest rates in the short-run?
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What is the term used to describe a situation where interest rates cannot fall below a certain level?
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What happens to people's incomes and saving during a recession?
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What is the accelerator effect, according to Keynes?
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Why did Keynes disagree with classical theorists' approach to balancing the government budget?
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What is the main story, according to Keynes, in the interaction between excess supplies in different markets?
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What happens to the business incentive to engage in fixed investment during a recession?
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What is the result of excessive saving, according to Keynes?
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What is the primary goal of active fiscal policy, according to Keynes?
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What is the purpose of deficit spending in an economy?
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What is the term used to describe the increase in final income arising from an increase in government spending?
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What is the formula used to calculate the Multiplier Effect?
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What is the assumption made about the workers' salaries in the calculation of the Multiplier Effect?
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According to Keynes, what determines the amount of investment?
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What is the main difference between the Classical Model and Keynes' approach to interest rates?
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What is the result of the Multiplier Effect in an economy?
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What is the term used to describe the process by which an increase in government spending leads to an increase in household income, which in turn leads to an increase in consumption and further increases in income?
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What is the purpose of increasing taxes during boom times in an economy?
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What is the term used to describe the change in income due to a permanent change in the flow of expenditure?
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What is the primary driver of investment spending?
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What is the relationship between investment spending and income?
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What is the equation of the 45° line in figure 5.4?
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What occurs when the level of income is lower than Yo?
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What is the point where the line A=Y intersects the line A = C + I?
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What is the level of income at which the aggregate spending function A intersects the 45° line?
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What is the relationship between aggregate spending and total income at equilibrium?
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What is the purpose of combining C and I to obtain aggregate spending?
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According to Keynesian economics, what is the impact of changes in aggregate demand on real output and employment?
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What is the primary reason for the comeback of Keynesian theory since the mid-1980s?
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What are the two types of spending in the simple Keynesian macroeconomic model?
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What is the condition for an economy to be in equilibrium in the simple Keynesian macroeconomic model?
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What is the term used to describe the part of consumption that is independent of the level of income?
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What is the relationship between aggregate demand and real output and employment, according to Keynesians?
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What is the focus of many Keynesians in terms of economic policy?
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What is the term used to describe the slope of the consumption function?
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What is the name of the system that, in effect, spread the stern German monetary policy all over Europe?
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What are the six principal tenets of Keynesianism, according to Blinder (1987)?
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Study Notes
Introduction to Macroeconomics
- Macroeconomics originated in the 1930s during the Great Depression
- Development of macroeconomics led to a better understanding of how to combat economic crises and stimulate long-term growth
- John Maynard Keynes made significant contributions to macroeconomic policy
Economic Schools of Thought
- There are three main economic schools of thought:
- Free Market Economics (also known as Orthodox Theory, Neo-Classical Theory, Conservative Economics, or Capitalistic Economics)
- Marxist Economics (also known as Socialist Economic Theory or Communist Economic Theory)
- Keynesian Economics (also known as the Theory of the Mixed Economy or Interventionist Economics)
Free Market Economics
- Major beliefs:
- Human beings are motivated by profit and self-interest
- Businesses should be given a free hand in all economies
- Competition between businesses should be promoted
- Oppose high taxes and nationalization
- Believe that government should ensure a conducive environment for business
- Support a capitalist economic system with private ownership of factors of production and private property rights
- Countries that have practiced free market economics include the USA, Switzerland, and Singapore
Marxist Economics
- Major beliefs:
- Human beings are not driven by self-interest
- Economy should be based on cooperation rather than competition
- Property rights should not vest with individuals
- Believe that profit should be eliminated
- Support a socialist economic system
- Countries that have practiced Marxist economics include the former Soviet Union, Cuba, and North Korea
Keynesian Theory
- Developed in response to the Great Depression
- Emphasizes the importance of aggregate demand in the economy
- Argues that the economy can be stuck in a state of underemployment equilibrium
- Government intervention is necessary to stimulate demand and achieve full employment
Keynes vs Classical Economic Theories
- Keynesian economics focuses on aggregate demand and its effects on output and inflation
- Classical economists believe that prices will adjust to achieve full employment
- Keynes argued that wages are not flexible and that interest rates cannot fall below zero
Excessive Saving and Recessions
- Excessive saving leads to a decrease in aggregate demand
- Decrease in aggregate demand leads to a recession
- Keynes argued that people will resist nominal wage reductions and that excessive saving results in unemployment
Government Policy and Fiscal Policy
- Fiscal policy is the behavior of governments in raising money to fund current spending and investment
- Keynes suggested that active government policy is necessary to manage the economy
- Deficit spending can stimulate the economy during recessions
- Reducing government spending and increasing taxes can help suppress inflation during booms
The Multiplier Effect
- The multiplier effect is the change in income due to an exogenous increase in expenditure
- The multiplier is calculated as 1 / (1 - MPC), where MPC is the marginal propensity to consume
- Example: If the government increases expenditure by R100,000 and the MPC is 0.8, the multiplier is 5, and the cumulative effect is R500,000
Interest Rates
- Classical model: supply of funds determines the amount of fixed business investment
- Keynesian model: amount of investment is determined by long-term profit expectations and interest rate
Summary of Keynesian Economics
-
Six principal tenets:
- Aggregate demand is influenced by public and private decisions
- Changes in aggregate demand have a greater impact on real output and employment than on prices
- Prices and wages respond slowly to changes in supply and demand
- Unemployment is subject to the caprice of aggregate demand
- Activist stabilization policy is necessary to reduce the amplitude of the business cycle
- Combating unemployment is more important than conquering inflation### Types of Spending in an Economy
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In an economy with households and firms, there are two types of spending: consumption spending (C) and investment spending (I)
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Consumption spending (C) is spending by households on consumer goods and services
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Investment spending (I) is spending by firms on capital goods
Economy in Equilibrium
- The economy is in equilibrium when Aggregate Spending (A) equals Aggregate Income (Y)
- Aggregate Spending (A) consists of consumption spending (C) and investment spending (I), i.e., A = C + I
- The economy is in equilibrium when C + I = Y
Consumption Function
- The consumption function shows the relationship between consumption expenditure by households and total income
- The consumption function has three important characteristics
- Autonomous consumption is the part of consumption that is independent of the level of income, financed by other sources of income (e.g., savings or credit)
- Induced consumption is the part of consumption that is determined by the level of income, indicated by the slope of the consumption function
Investment Spending
- Investment spending is more variable and less predictable than consumption spending
- Investment spending is often the main cause of fluctuations in economic activity
- I is not primarily a function of income, but is determined by:
- Expected profitability from the investment
- Interest rate for borrowing capital or investing capital
- Opportunity cost of using the funds
- Level of risk and or uncertainty
Macroeconomic Model of Income Determination
- To construct a simple macroeconomic model, we add C and I at each level of Y
- The equilibrium point is where the line A=Y intersects the line A = C + I
- The equilibrium level of income Yo is the level of income at which the aggregate spending function A intersects the 45° line
- At any level of income lower than Yo, there is excess demand (A > Y), and at any level of income higher than Yo, there is excess supply (A < Y)
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Description
Learn about the origin and development of macroeconomics, from the Great Depression to modern-day economic growth and crisis management. Explore the role of John Maynard Keynes and his contributions to macroeconomic policy.