Keynesian Economists – Principles of Macroeconomics Final

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Keynesian Economists, Principles of Macroeconomics Final Exam

The key words in this Macroeconomics course include Keynesian Economists, Principles of Macroeconomics

According to Keynesian economists, prices tend to be ______________. As a result, Keynesian economists focus on _____________ changes and aggregate ____________.

flexible; long-run; demand

sticky; short-run; demand

flexible; short-run; supply

sticky; long-run; supply

Explanation: Keynesian economists believe that prices are sticky because of contracts and money illusion. Because of price stickiness, when aggregate demand decreases, Keynesian economists believe that the economy does not self-adjust, contrary to the beliefs of classical economists. As a result, Keynesian economists focus on short-run changes that they believe shift aggregate demand back to equilibrium.

According to classical economics, a decrease in aggregate demand causes the price level to _____________ in the long run. On the other hand, an increase in aggregate demand causes the price level to _____________ in the long run. These changes occur because of _____________.

increase; decrease; price flexibility

decrease; increase; price flexibility

decrease; increase; government intervention

increase; decrease; government intervention

Explanation: Classical economists believe that prices adjusted to long-run output equilibrium without the need for government intervention because of price flexibility. When aggregate demand decreases, prices decrease to restore the long-run equilibrium. When aggregate demand increases, prices increase to restore the long-run equilibrium.

Consider these four graphs. Graph ____ depicts the conditions of the Great Recession, and graph _____ depicts the conditions of the Great Depression.

C; A

C; D

A; C

D; B

Explanation: Graph C refers to the Great Recession and graph D refers to the Great Depression. The U.S. economy saw declining prices but no change in long run aggregate supply during the Great Depression, which is consistent with graph D. During the Great Recession, he impact of the financial crisis on long run aggregate supply and aggregate demand is consistent with graph C, in which the price level did not change.

Identify which of the following graphs will be drawn by classical and Keynesian economists, respectively, for an economy experiencing a decrease in wealth. Note that E1 and E2, respectively, are the initial and final equilibrium points before and after the wealth decrease.

Classical: Fig 4; Keynesian: Fig 1

Classical: Fig 1; Keynesian: Fig 2

Classical: Fig 2; Keynesian: Fig 3

Classical: Fig 2, Fig 4; Keynesian: Fig 1, Fig 3

Explanation: The economy experiences a decrease in wealth. This implies that the AD curve should shift left, irrespective of the classical or Keynesian point of view. Hence, we can exclude figures 2 and 3, since both these figures involve a rightward shift of the AD curve. According to classical economists, the economy is self-correcting and always ends up at full-employment output. So in classical economics, demand shifts only involve changes in the price level, with output being at the full-employment level. This is the case as shown in Figure 4. On the other hand, Keynesian economists hold the view that aggregate demand changes bring fluctuations to the economy and therefore demand shifts can result in equilibrium situations in which the real GDP drifts away from potential GDP. This is the case depicted in Figure 1.

If a Keynesian economist was offering policy advice to stimulate an economy, which of the following would apply?

reduce unemployment benefits for 6 months

reduce licensing requirements for cosmetologists.

let the economy work itself out, without any government action

create a program that would fix and repair existing infrastructure and highways

Explanation: An infrastructure program designed to fix infrastructure is a direct injection of money into the economy by the government. This program also creates jobs to lower the unemployment rate. This type of policy directly increases aggregate demand, and is the underlying principle behind Keynesian economics.