Exam 15: Modern Macroeconomics: From the Short Run to the Long Run

When generating a political business cycle, a politician chooses lower unemployment in the _______ over inflation and crowding out in the _______.

Friedman and Keynes:

When the level of output is below potential output, the unemployment rate is higher than the natural rate.

Recall Application 2, "Elections, Political Parties, and Voter Expectations," to answer the following questions: -Does the performance of the economy in 2007 support the theory expressed in the application?

AN UNFORTUNATE GAMBLE What explained the decision by the Japanese government to increase taxes in the 1990s when the economy was still suffering from a recession? The Japanese government sharply increased taxes on consumption in 1997—just as Japan was in the midst of its prolonged recession. Why did the government do this? The reasons were clear. As the economy slumped, fiscal deficits were increasing, as taxes fell and government spending rose. Policy makers understood that their society was aging rapidly and that this would mean even more demands on the public sector in the near future. They became convinced that the current fiscal deficits plus the inevitable future demands on the government would lead to long-run increases in government spending. To avoid crowding out of investment in the future, they decided to tax consumption in order to reduce it. Their goal was to match the increases in government spending with decreases in consumption spending and therefore not experience crowding out of investment. Although policy makers were right to consider the long-run consequences of increases in government spending, they made the unfortunate gamble that the short-run effects of the tax increase would not hinder the economy’s recovery. They were wrong, because the tax increase prolonged the recession. Although it is important to consider the long-run consequences of policy, it is important to understand the short-run consequences as well. -According to the application, what was the Japanese government's gamble?

Recall Application 2, "Elections, Political Parties, and Voter Expectations," to answer the following questions: -Evidence suggests that Republican presidents usually guide the economy to faster economic growth than their Democratic counterparts.

Crowding out refers to the reduction of investment that can occur when government spending rises.

Figure 15.2 -Refer to Figure 15.2. If the economy is currently at Point D producing output level Y₂:

Which of the following will cause investments to decrease?

In macroeconomics, the "short run" denotes the time period:

Patinkin and Modigliani argue that Keynes' argument that demand could fall below production would hold only if:

What is a wage- price spiral?

Suppose the economy is in a recession and the unemployment rate is higher than the natural rate. Using aggregate supply and aggregate demand, explain how the economy adjusts back to potential GDP.

When the economy is not at full employment, which component of GDP adjusts automatically in the long run to bring the economy back to full employment?

If the economy is operating above full employment, wages in the economy will rise.

If Say's Law holds true, then if the economy produced $10 trillion this year:

In the long run:

Assuming that the economy is in the long run equilibrium at full employment, a reduction in the money supply will cause a(n):

Is money neutral in the long run? Explain.

The aggregate demand curve shows the relationship between prices and the