Exam 18: Alternative Views in Macroeconomics

How do rational-expectation theorists explain unemployment?

What does the rational-expectations hypothesis suggest about the forecasts that people make concerning future inflation rates?

According to the Lucas supply function, how will firms react to a positive price surprise?

Critics of supply-side theory say that cuts in tax rates may not necessarily raise tax revenue. What is their argument?

What criterion should be used for deciding whether or not people are said to have rational expectations?

Assume that the economy is represented by the following function Y = $9 Trillion + $500 billion (P - P^e) . If the current price level is 1.0 and people expect it to rise to 1.1 what will be the new level of GDP if their expectations of inflation are anticipated correctly?

What assumption is made in traditional macroeconomic models about how expectations are formed? Explain the shortcomings of this assumption.

Explain what the velocity of money means.

Supporters of supply side theory will point to the end of the 1982 recession as proof of the success of the tax cuts of the 1980s in stimulating the economy. However, critics argue that there is an alternative explanation for the end of the 1982 recession. Explain their reasoning.

Identify what occurred in the 1970s that helped motivate the formulation of new classical economics.

-Refer to the above figure. Suppose the economy is at Point A. According to the rational expectation theory, what impact will an unanticipated increase in money supply have in the short run? Use the figure to answer the question.

Define the velocity of money. If the demand for money depends on the interest rate, will velocity be constant? Why or why not?

What policy does Milton Friedman advocate for the Federal Reserve?

Most monetarists argue against an activist monetary policy. Explain why. Explain the type of monetary policy that monetarists do advocate.

Traditional economic models assume that people form their expectations of future inflation by assuming present inflation will continue and if they are wrong simply adjust their expectations by some fraction of the difference between their original forecast and the actual inflation rate. Why is this not consistent with the assumptions of microeconomics?

Why is it difficult to test whether the velocity of money is constant over time?

-Refer to the figure above. According to Keynes, what changes will occur if there is an increase in government spending or an increase in money supply. Explain using the graph.

Suppose that the stock of money is $150 billion and nominal GDP is $750 billion. Compute the income velocity of money.

Related to the Economics in Practice on p. 346 [658]: What was the conclusion of the study concerning how people form their expectations?

-Refer to the above figure. According to Keynes, what will the impact be in the long run of an expansionary monetary policy after all the adjustments have been made?