QUESTIONS IN ECONOMICS
1.The AS curve does not describe the same kind of relationship between price and quantity as a microeconomic supply curve. Why?
Because AS curve is derived from the macroeconomic equilibrium points of IS (Investment and Savings) and LM(Liquidity and Money Supply) curves. AS curve depends on the limits of the economy, if all the resources in the economy are used efficiently, then AS curve becomes parallel to the general price level dimension and perpendicular to the Real GDP axis. If all the resources are used, then it becomes parallel to the Real GDP axis.
A supply curve is just for a company in the economy, and it is determined by the variables at company level.
2.It has been said that U.S. citizens do not have much propensity to save, and the low interest on savings accounts may be a reason. What would happen to the economy if, all else remaining the same, savings interest increased enough that we would have greater propensity to save? What aspects of the economy would be affected?
Increasing interest rates might cause an increase in savings, however, propensity to save is more determined by the economic attitudes of the individuals. If they think, the increase in interest rate will give them the opportunity to make more money without working, then they might invest their money in the bank accounts rationally. So a belief change is needed to change the propensity to save. For example, in some developed economies such as U.S. or European countries, people's consumption rates are so high and propensity to save is so low because of the economis culture. When an individual consume more and buy luxury cars and houses, he receives prestige.
Increasing interest rates might damage the investments. If the interest rates are so high, even more than return rates of varying investments, investors might prefer making money on interest gains, and they stop their physical investments. In this case, the economy suffers more.
3. Suppose MPC is 0.8 initially. Households then change their behavior so that the MPC falls to 0.75. What happens to aggregate expenditures? Why?
When MPC is 0.8 then the consumption multiplier is 1/(1-0.8)= 5 and when MPC is 0.75 then multiplier is is 4. That means one dollar expenditure in the economy creates 5 dollars income in the first case anad 4 dollars in second case. In the second case, people instead of spending they save more money when they earn. That causes a decrease in aggregate expenditures.
4. Explain what would cause the government purchases function to increase. Will a change in social security spending affect government purchases?
Goverment expenditure occurs as a result of political decisions. There is no economic explanation for them. Depending on current government ideology and political environment, government expenditure is shaped accordingly.
Any change in social security expenditure affects government purchases. For example, when new extra rights are given to public workers, government has to pay extra cost and vice versa.
5. For each of the following, explain whether it shifts the short-run aggregate supply curve, the long-run aggregate supply curve, or the aggregate demand curve (or more than one of these).
a. Households decide to save a smaller share of their disposable income.
Aggregate demand increases, but it does not affect the short term or long term supply. b. There is an 8-week strike in the steel industry. That decreases short supply so short term curve shifts down, however, in the long run supply stays same. Aggregate demand does not change.
c. A drought in the Midwest causes poor wheat harvest.
Short supply curve shifts down but long run supply curve or aggregate demand do not change. To have a change in the long run, the drought should be continous. d. The labor force participation rate increases. That increase the number of potential workers which causes a decrease in the real wages. This way the production costs decrease thanks to a decrease in labor cost. The long run and the short run supply curves shift upward. Aggregate demand does not change.
6. How is an aggregate demand curve derived? What would cause the aggregate demand curve to shift to the right?
Aggregate demand curve is derived from equilibrium points of the IS (Investment-Saving) – Goods Market Equilibrium- and LM (Liquidity-Money Supply) – Money Market Equilibrium-. In another words, AD shows us the points or situations that simultenaously money and goods (real) markets are on their equilibrium. Any increase in any kind of expenditure (Consumption, government expenditure or export) cause a shift of AD to the right.
7. What is a consumption function? Describe the graph of a consumption function and explain its shape. If total spending is consumption plus investment spending, how does an increase in the interest rate affect total spending?
C=a+bY where a is constant consumption ( it does not depend on disposable income and even individual has zero income it occurs); b is propensity to consume (it shows how much share of disposable income an individual spends); and Y is disposable income. Consumption line shows us that any increase in disposable income causes an increase in consumption.
If interest rates goes up, it might affect an individual consumption function structure. If this individual believes that it is worth keeping money in an bank account with an interest gain, then his propensity to consume decreases, and his consumption line becomes more horizontal. This individual spends less relatively.
References
Mankiw, N. Gregory. (2012). Principles of Macroeconomics. South West CENGAGE Learning, 6th Edition.
Arnold, Roger A. (2008). Macroeconomics. South West CENGAGE Learning, 9th Edition.
