Term
| Which approach did the Classical Economists use in determining the interest rate, and why did Keynes think this approach left the interest rate indeterminate? |
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Definition
| loanable funds market. Keynes argued that savings and investment were more inelastic than the Classicalists thought. He said interest rates were determined by people's "liquidity preference" or demand for money - a measure of the willingness of individuals to part with their liquid assets. Money, he argued, was much more responsive to periods of excessive saving, and would allow faster changes in the interest rate. In the case of a liquidity trap (interest rate so low we can only expect it to go up), changes in the money supply will not affect the interest rate. |
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Term
| Which approach did Keynes use in determining the interest rate, and why did Hicks think that Keynes’ approach was vulnerable to a similar criticism as Keynes had of the Classicalists'? |
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Definition
| supply and demand for money. Hicks added the IS curve, arguing that Keynes' liquidity preference theory failed to account for the long run effects of changes in investment demand. Ex: investment demand rises, causing Y to go up. Eventually, interest rates my also rise due to an increase in the demand for money that comes with a higher level of income. |
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Term
| What model did Hicks develop to determine the equilibrium interest rate? |
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Definition
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Term
| How did Hicks’ approach (IS/LM) avoid the problems in both of the previous approaches (loanable funds market and money market) when it came to determining interest rates? |
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Definition
The IS/LM model accounts for the long term effects of changes in both markets. Eventually, Hicks thought changes in Y would lead to changes in r and vice versa.
Keynes said an increase in the demand for money (investment demand) would cause Y to increase. Hicks then suggested that an increase in the demand for money as a result of the higher level of income would lead to an increase in interest rates.
Similarly, the Classicalists said that an increase in savings would lead to an increase in r. Hicks said an increase in velocity would then cause Y to go up as well.
Both of these forces are incorporated in the IS/LM model so that an increase in investment shifts the IS curve to the right and thereby raises both Y and r – outside the 'trap'. |
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Term
| What are the assumptions of the Harrod Domar Growth Model? |
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Definition
1. Output is a function of capital stock
2. The marginal product of capital is constant; the production function exhibits constant returns to scale. This implies capitals marginal and average products are equal.
3. Capital is necessary for output
4. The product of the savings rate and output equals savings
5. The change in capital stock equals investment minus the depreciation of capital stock
There is a precise rate of investment that is compatible with full employment
Fixed proportions in the combination of labor and capital |
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Term
| What is the nature of the equilibrium that results from the Harrod-Domar assumptions? |
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Definition
| It is a razor's edge equilibrium. If the actual rate of growth. When the economy deviates slightly from the natural growth rate, the consequence is either growing unemployment or prolonged inflation, as the system has no built in equilibrating force. |
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Term
| What are the assumptions of the "neo-classical" growth model? |
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Definition
| same as harrod domar, but there are diminishing returns to capital |
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Term
| How does the equilibrium of the neoclassical model differ from that of the Harrod-Domar model? |
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Definition
| Neoclassical model has a stable steady state equilibrium as opposed to a razor's edge equilibrium. |
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Term
| Name two MIT economists who developed the Neoclassical Growth model |
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Definition
| Robert Solow and Paul Samuelson |
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Term
| Henry Simons' views on government policy regarding monopoly power in comparison to later Chicago school |
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Definition
| Simons favored anti-trust laws and government regulation of corporate power. Chicago schoolers favored deregulation |
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Term
| Henry Simons' views on government policy regarding monetary policy in comparison to later Chicago school |
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Definition
Simons supported quantity theory of money but wanted the government to stabilize the price level. Fiscal policy was more effective at ending recessions.
When used, monetary policy should aim to stabilize the price level rather than the quantity of money. The creation of short term and liquid securities threatens financial stability.
Chicago schoolers wanted the central bank to control the MS through open market operations |
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Term
| Henry Simons' views on government policy regarding taxation in comparison to later Chicago school |
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Definition
Progressive income and consumption taxation to promote equality.
Chicago schoolers liked low taxes |
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Term
| Henry Simons' views on government policy regarding international trade in comparison to later Chicago school |
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Definition
| Low tariffs to promote international trade. in line with chicago school |
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Term
| According to Friedman’s Theory of the Consumption Function, what is the major determinant of consumer spending? |
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Definition
| Permanent Income Hypothesis. An individual's real wealth, not current real disposable income. real wealth takes into account physical (shares, bonds, property) and human (experience, education) assets. These influence the consumer's ability to earn income. The consumer can then make an estimation of anticipated lifetime income. |
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Term
| What does Friedman's Theory of the Consumption Function imply about the size of Keynesian multiplier effects of temporary changes in investment or government spending? |
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Definition
| Temporary changes in capital costs have little effect on production |
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Term
| According to Friedman, what was the cause of the Great Depression of the 1930s? |
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Definition
| According to Friedman, many economists falsely attributed the Great Contraction to the sheer use of monetary policy by the Federal Reserve. In reality, he says, the Fed simply pursued the wrong policies. If they had done what they were supposed to – increase the money supply (as opposed to decreasing it) – the contraction would not have been as severe. |
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Term
| According to Friedman, how should monetary policy be conducted? |
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Definition
| Open market operations – buying and selling of treasury bonds by the Fed to control interest rates. Keep prices stable, avoid shocks and prevent money itself from being a major cause of economic disturbance. |
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Term
| What arguments does Friedman make in support of his monetary policy recommendations? |
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Definition
| History has shown that the economy, left on its own, is subject to shocks and disturbances. Stagflation in the 1970's showed that fiscal policy was incapable of combating a recession on its own. |
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Term
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Definition
Y axis inflation
X axis unemployment
downward sloping |
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Term
| According to Milton Friedman, why does the short run Phillips curve slope the way it does? |
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Definition
| So long as the average rate of inflation remains fairly constant, as it did in the 1960s, inflation and unemployment will be inversely related. |
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Term
| According to Friedman’s “natural rate” hypothesis, what does the long run Phillips Curve look like? |
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Definition
| Vertical line on the natural rate of unemployment |
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Term
| Compare how expectations are formed according to Friedman’s “adaptive expectations” theory. Also compare the effectiveness of monetary policy according to these two theories (adaptive expectations and natural rate hypothesis). |
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Definition
In the long run workers will expect higher inflation, and demand higher wages. If real wages rise too quickly, they will move beyond the natural rate and unemployment will increase - in the long run, there is NO tradeoff between inflation and unemployment
For policies, this means central banks should be careful not to set the target rate of unemployment above the natural rate. |
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Term
| Name the two Nobel Winning economists who developed "Human Capital Theory" |
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Definition
| Gary Becker and Theodore W. Schultz |
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Term
| According to human capital theory, how would you decide whether to attend college? |
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Definition
| Cost Benefit analysis. Go to college if the expected rate of return is greater than the costs (including opportunity) of not going. |
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Term
| Who was the author of A Treatise on the Family? |
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Definition
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Term
| According to Becker's theory, why would married spouses specialize in different roles in the household and in the labor market? |
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Definition
| If each spouse specializes in the role where they have a comparative advantage, the division of labor will make the household more efficient. |
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Term
| According to Becker's theory, how and why would an increase in women’s wages affect the birthrate? |
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Definition
| Women with higher wages have a higher opportunity cost of not working (spending time with kids). Higher wages will reduce their demand for children and they will substitute away from mothering towards more labor. |
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Term
In The Calculus of Consent, James Buchanan and Gordon Tullock analyze the optimal rule for what proportion of decision makers should be required to agree to make a collective decision.
What is their conclusion and why? |
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Definition
They conclude that decisions with potentially high external costs (political externalities) should require unanimity or at least supermajority systems.
Methodological Individualism - collective action is composed of individual actions. Only constitutional changes, which can be shown to be in the interest of all interested parties can be judged as "improvements" |
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Term
| Who was the author of “A New Principle of Just Taxation,” which influenced Buchanan’s thinking on public choice? |
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Definition
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Term
| Briefly discuss the assumptions and conclusions of the “Coase Theorem.” |
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Definition
| Where transaction costs are low to nil, market negotiation will result in the optimally efficient allocation of rights and distribution of resources. In such a situation, there is no need for state intervention, as the individuals and firms will negotiate until they eventually reach the optimal outcome. |
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Term
| According to Richard Posner, how should judges make decisions in cases in which transactions costs are high? |
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Definition
First, they should try to reduce transaction costs by clearly defining property and contract rights and ensuring inexpensive and effective remedies for any breach.
In cases where transactions costs are inevitably high, courts should mimic the economically efficient market outcome in their judicial determinations. |
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Term
| According to Robinson’s interpretation of Keynes, what determines the price level? |
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Definition
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Term
| According to Robinson, how are economic growth and poverty related? |
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Definition
| Growth does not alleviate poverty. It actually increases it in both subjective and absolute terms |
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Term
| What determines relative earnings according to Robinson? |
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Definition
| The bargaining power of each type of labor |
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Term
| What determines real wages of each type of labor according to neoclassical theory? |
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Definition
| The marginal product of their labor to society |
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Term
| Do Monetarists view the money supply as exogenous or endogenous? Why? |
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Definition
| Exogenous. They believe the quantity of money supplied to an economy is perfectly inelastic with respect to alternative possible interest rates. Observed changes in the money supply are the result of shifts in the money supply function over time – from changes in the interest rates caused by actions such as open market operations |
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Term
| Do post-Keynesians view the money supply as exogenous or endogenous? Why? |
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Definition
| Endogenous. They believe that the stock of money in a country is determined by demand for bank credit, which is causally dependent on the economic variables that affect the level of output. |
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Term
| Do Monetarists view the wage rate as exogenous or endogenous? Why? |
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Definition
| Endogenous. The supply of labor is a function of real wage and permanent income. |
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Term
| Do post-Keynesians view the wage rate as exogenous or endogenous? Why? |
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Definition
| Exogenous. The wage rate determines the price level |
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Term
| How does the Cowles Foundation approach to the statistical analysis of business cycles differ from the approach of Mitchell and Burns NBER studies? |
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Definition
| Multi-equation, general equilibrium model as opposed to single-equation, partial equilibrium model |
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Term
| Some economists use “partial equilibrium” models and others use “general equilibrium” models. Explain the difference between these two approaches. |
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Definition
Partial equilibrium - studies equilibrium of a single market (individual firm, consumer, seller and industry). It studies one variable in isolation keeping all the other variables constant.
General equilibrium - Studies equilibrium of all markets. Includes all relevant economic variables and examines how they interact. |
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Term
| Which approach, partial of general equilibrium, is associated with the work of Milton Friedman? Which approach is associated with the work of the Cowles Foundation? |
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Definition
Friedman - partial
Cowles Foundation - general |
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Term
| Name three of the founders of the Econometric Society. |
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Definition
| Schumpeter, Menger, Schultz |
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Term
| Name three non-American economists who won Nobel prizes for their work in econometrics. |
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Definition
| Tinbergen, Frisch, Haavelmo |
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Term
| Why was Simons optimistic or pessimistic about the future prospects for “liberal” (in the classical sense) economic policies? |
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Definition
| He was optimistic: “liberal reform faces no great obstacles. There is here no strongly adverse drift of policy or opinion – only intellectual confusion and hesitation.” |
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Term
| Friedman discusses three “guides” or targets for monetary policy. What are those three targets, which does he favor and why? |
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Definition
Exchange rates (too small a portion of US economic activity, makes us dependent on other countries)
Price level - takes too long to reflect changes in policy
Money supply - better than the other two |
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Term
| 2. Why did Friedman think that monetary policy could not peg interest rates for more than very limited periods of time? |
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Definition
| Prices rise due to higher rate of monetary growth, and the public assumes prices will continue to rise, so: “Borrowers will then be willing to pay and lenders will then demand higher interest rates.” |
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Term
| Of what significance is the fact that we live in and act in time for economic theory? How does neoclassical theory ignore this? |
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Definition
Keynes broke down the compartments of "real" and "monetary" theory. He showed how money is a necessary feature of an economy in which the future is uncertain and he showed what part monetary and financial institutions play in the functioning of the "real" economy. i.e. plans for investment made based on expectations of profit, not interest rates.
Neoclassical theory ignores the difference between money and real wage rates, so demand for labor (based on wages) is flawed. |
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Term
| According to Robinson, what did Keynes neglect and in what respect was Kalecki's theory superior to Kenyes'? |
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Definition
| Keynes ignored theory of value and distribution. Kalecki's theory brought imperfect competition into the mix and emphasized the influence of investment on the share of profits. Political trade cycle. More of a "General Theory" |
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Term
| Describe Kalecki's political trade cycle. |
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Definition
| "Captains of industry" do not want full employment, which would give workers more bargaining power and cut into their profits. |
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Term
| How does Robinson's "second crisis of economic theory" differ from the first? |
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Definition
| The first crisis arose from the breakdown of a theory (classical) which would not account for the LEVEL of employment. The second crises arises from a theory that cannot account for the CONTENT of employment. |
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