Chapter 12 Macroeconomics

Keynesian Perspective

Focuses on the idea that firms produce output only if they expect it to sell

Real GDP

The amount of goods and services actually sold in a nation

Recessionary Gap

Equilibrium at a level of output below potential GDP

Inflationary Gap

Equilibrium at a level of output above potential GDP

Keynes Identified Three Factors that Affect One Consumption

Disposable income

Expected future income

Wealth or credit

Disposable Income

Income after taxes

These Fall into Four Categories

Producer’s durable equipment and software

Nonresidential structures (such as factories, offices, and retail locations)

Changes in inventories

Residential structures (such as single-family homes, townhouses, and apartment buildings)

When a Business Decides to Make an Investment in Physical or Intangible Assets, the Firm Considers Both

The expected investment benefits (future profit expectations)

The investment costs (interest rates)

Keynes Recognized that the Government Budget Offered a Powerful Tool for Influencing Aggregate Demand

More government spending could stimulate AD (or less government spending reduce it)

Lowering or raising tax rates could influence consumption and investment spending

Two Sets of Factors Can Cause Shifts in Export and Import Demand

Changes in relative growth rates between countries

Changes in relative prices between countries

The Keynesian View of Recession is Based on Two Key Building Blocks

Aggregate demand is not always automatically high enough to provide firms with an incentive to hire enough workers to reach full employment

The macroeconomy may adjust only slowly to shifts in aggregate demand because of sticky wages and prices

Sticky Wages and Prices

A situation where wages and prices do not fall in response to a decrease in demand, or do not rise in response to an increase in demand

Coordination Argument

Downward wage and price flexibility requires perfect information about the level of lower compensation acceptable to other laborers and market participants

When a Firm Considers Changing Prices, it Must Consider Two Sets of Costs

Changing prices uses company resources

Frequent price changes may leave customers confused or angry

Menu Costs

Costs firms face in changing prices

Macroeconomic Externality

Occurs when what happens at the macro level is different from and inferior to what happens at the micro level

Expenditure Multiplier

Keynesian concept that asserts that a change in autonomous spending causes a more than proportionate change in real GDP

The idea that not only does spending affect the equilibrium level of GDP, but that spending is powerful

Change in Y/Change in spending > 1

Reason for it is that one person’s spending becomes another person’s income, which leads to additional spending and additional income

-The cumulative impact on GDP is larger than the initial increase in spending

Phillips Curve

The tradeoff between unempoyment and inflation

Keynesian Macroeconomics

Argues that the solution to a recession is expansionary fiscal policy

Expansionary Fiscal Policy

Tax cuts or increases in government spending designed to stimulate aggregate demand and move the economy and move the economy out of recession

When the Economy is Operating Above Potential GDP, Unemployment is Low, but Inflationary Rises in the Price Level are a Concern

The Keynesian response would be contractionary fiscal policy, using tax increases or government spending cuts to shift AD to the left

The result would be downward pressure on the price level, but very little reduction in output or very little rise in unemployment

Contractionary Fiscal Policy

Tax increases or cuts in government spending designed to decrease aggregate demand and reduce inflationary pressures