Deck 12: Thinking Like a Modern Macroeconomist

Question 1

What is the fallacy of composition and how does it relate to the Keynesian model?

Answer 1

The fallacy of composition is the logical flaw of asserting that what is true for one part of something (like the economy)is true for the entire thing.Keynesian economics was based on recognition of the fallacy of composition; some aspects of the whole economy,Keynes argued,can't be understood simply by understanding its parts.Microeconomics and macroeconomics were seen as distinct.

Question 2

Describe the macroeconomic precepts of Classical economists.

Answer 2

Classical economists had a number of general precepts about macro policy based on their informal models of the macroeconomy: 1)the government should always balance the budget; 2)the government should maintain a strong currency; 3)the government should be prepared for the central bank to be the lender of last resort.

Question 3

What are three policy implications of the DSGE model? Give an example for each.

Answer 3

The DSGE model reveals three potential problems with government policy.The first is the Ricardian equivalence problem,which states that actions by the government will be offset by counteractions by individuals who seek to optimize over the future.For example,if the government decides to run a deficit to expand the economy,individuals will realize that repaying the debt accrued will require higher future taxes,and thus they will save more in anticipation of the higher taxes,thus offsetting the expansionary effect of the government policy.The second problem is the time inconsistency/credibility problem.This is the problem that the best government policy from today's point of view can turn out to be a policy that the government wants to change in the future,and that rational individuals can anticipate this.As an example,to encourage the development of new drugs,the best policy is to offer patent protection.Once the drug is developed,however,the best policy is to revoke patent protection.Firms ought to be able to anticipate this problem and may research new drugs expecting government to revoke the patent once the drug is developed.The third problem is the Lucas critique problem.Lucas has pointed out that because government policies can affect the behavior of individuals,historical data can lead to misleading predictions about the impact of a new policy.In other words,the government does not act in a vacuum.When it sets a policy,it changes the context in which that policy operates.For example,there may be a tradeoff between inflation and unemployment,but once government decides to pursue a high-inflation,low-unemployment policy goal,it fundamentally alters the relationship between inflation and unemployment.(LO5)

Question 4

What problem regarding the assumed relationship between consumption and income did the macro models of the 1960s begin to reveal? How was this problem addressed?

Question 5

How did the macroeconomists of the 1960s proceed as they moved away from the top-down model of the economy?

Question 6

Why is it important to learn about modern macroeconomic theory?

Question 7

How are engineering and scientific models different?

Question 8

What is New Classical macroeconomics?

Question 9

Why do you think modern macroeconomist Robert Lucas said that he would resign if he were appointed to the President's Council of Economic Advisers?

Question 10

What is a top-down model of the economy? Why would a macroeconomist choose such a model?

Question 11

What are the advantages and disadvantages of the standard macro model?

Question 12

Are all modern macroeconomists as unconcerned about policy implications as Robert Lucas,who said that he would resign were he appointed to the President's Council of Economic Advisers?

Question 13

What is the difference between the standard macro model and the modern macro scientific model?

Question 14

What historical event led to the emergence of the Keynesian model of the macroeconomy?

Question 15

What assumption is represented by each of the letters in the name of the DSGE model?

Question 16

What is the complex systems approach to modern macroeconomics?

Question 17

When your author says that New Classical macroeconomics was not really macroeconomics at all,what does he mean?

Question 18

Describe the macroeconomic models of Classical economists.

Question 19

Which model that you've learned so far best typifies a standard macro model? Is it an engineering model or a scientific model? Explain.

Question 20

Give an overview of the historical development of macroeconomics,beginning with classical economics and ending with modern macroeconomics.

Question 21

Which set of underlying dynamic assumptions could lead to prices that are always market-clearing (equilibrium)prices with no persistent fluctuations?

Question 22

What would someone who recognizes the Ricardian equivalence problem say about using government deficit spending to stimulate the economy?

Question 23

What is assumed about market structures in the DSGE model? What is the result of this assumption?

Question 24

What is the Ricardian equivalence problem?

Question 25

What is the time-inconsistency/credibility problem?

Question 26

Summarize the basic properties of the DSGE model.

Question 27

What modern macro approach is best suited for taking into consideration the interactive feedback effects ignored by the DSGE model?

Question 28

What are the "dynamic assumptions" of a model? Contrast the underlying dynamic assumptions of the standard,DSGE and complex systems models of macroeconomics.

Question 29

Why does a general equilibrium model not require that you hold "all other things constant" like a partial equilibrium model (such as the simple supply and demand model)?

Question 30

What do the Ricardian equivalence problem and the time-inconsistency/credibility problem have in common?

Question 31

The individual described by the DSGE model has a perfectly-conventional time-additive utility function.What does this mean?

Question 32

How does the addition of insights from behavioral economics create even more possibilities for fluctuations in the aggregate economy?

Question 33

What does DSGE stand for? Where does the DSGE model fit within the context of the development of macroeconomics?

Question 34

What does it mean to have rational expectations? Is it the same as knowing exactly what will happen?

Question 35

What is the Lucas critique?

Question 36

What are two examples of the policy recommendations made by economists who favor the use of the DSGE model in crafting policy?

Question 37

According to the complex systems approach to macro economics and its dynamic assumptions of learning procedures,what will cause fluctuations in the aggregate economy?

Question 38

Which set of underlying dynamic assumptions could lead to a fluctuating price that never reaches equilibrium?

Question 39

Why is the collapse of the Tacoma Narrows Bridge relevant to modern macroeconomics?

Question 40

Give two reasons that the individual described by the DSGE model is assumed to live forever.

Question 41

How do economists solve very complicated models such as multiple-level pattern-finding learning models?

Question 42

What kind of expectations would lead to the following price behaviors?
a.

b.

c.

Question 43

Using the graph below,demonstrate how historical price expectations on the part of suppliers will impact a market in which the demand curve shifts to the right.How quickly will the market reach equilibrium?

Question 44

Using the graph below,demonstrate how rational price expectations on the part of suppliers will impact a market in which the demand curve shifts to the right.How quickly will the market reach equilibrium?

Question 45

How does the current state of the economy affect which model should be chosen?