Summary of chapters 21 up to 28 of the book Economics by Paul Krugman and Robin Wells (5th edition, ISBN: 978-1-319-18194-9. This material is relevant for the midterm of the course
Solution Manual for Economics 5th Edition By Paul Krugman, Robin Wells. A+
Practice questions + Answers - Chapter 21-30 - Economics 2 for IBA
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Making of Modern Macroeconomics (840051B6)
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Chapter 21 – Macroeconomics: The Big Picture
The nature of Macroeconomics
Macroeconomic Questions
Microeconomics focuses on how decisions are made by individuals and frms and the
consequences of those decisions. Macroeconomics examines the overall behavior of the
economy – how the actons of all the individuals and frms in the economy interact to
produce a partcular economy-wide level of economic performance.
Macroeconomics: The Whole Is Greater Than the Sum of Its Parts
Understanding a rubber-necking trafc cam gives insight to one important way in which
macroeconomics difers from microeconomics: many thousands or millions of individual
actons compound upon one another to produce an outcome that isn’tt simply the sum of
those individual parts. example: paradox of thrif: when families and businesses are
worried about the possibility of economic hard tmes, they prepare by cutng their spending.
This reducton in spending depresses the economy as consumers spend less and businesses
react by laying of their workers. A key insight of macroeconomics is that the combined
efect of individual decisions can have results that are very diferent from what any one
individual intended. The behavior of macroeconomy is greater than the sum of individual
actons and market outcomes.
Macroeconomics: Theory and Policy
Before the 1930s, economists tended to regard the economy as self-regulatig: they
believed that problems such as unemployment are resolved without government
interventon, through the working of the invisible hand. According to Keyiesiai
ecoiomics, (From 1936 onwards) economic slumps are caused by inadequate spending, and
they can be mitgated by government interventon. -> Moietary policy uses changes in the
quantty of money to alter interest rates and afect overall spending. -> Fiscal policy uses
changes in government spending and taxes to afect overall spending.
The Business Cycle
The economy’ts forward march isn’tt smooth. And the uneven pace of the economy’ts
progress, its ups and downs, is one of the main preoccupatons of macroeconomics
Charting the Business Cycle
Figure 21-3 The business Cycle Recessiois, or contradictons, are
periods of economic downturn when output and employment are
falling. Expaisiois, or recoveries, are periods of economic upturn
when output and employment are rising. The busiiess cycle is the
short-run alteraton between recessions and expansions. -> The point
in tme at which the economy turns from expansion to recession is a
busiiess-cycle peak. the point at which the economy turns from
recession to expansion is a busiiess-cycle trough.
The Pain of Recession
The most important efect of a recession is its efect on the ability of workers to fnd and
hold cobs. The most widely used indicator of conditons in the labor market is the
unemployment rate. Because recessions cause many people to lose their cobs, they hurt the
standard of living of many families. Recessions are also bad for frms: profts fall, small
businesses fail.
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,For inquiring minds – Defning Recessions and Expansions
There are no exact defnitons of recessions and expansions. In many countries,
economists adopt the rule that a recession is a period of at least two consecutve quarters
during which the total output of the economy shrinks.
Taming the Business Cycle
Modern policy makers try to “smooth out” the business cycle. They haven’tt been completely
successful. It’ts widely believed, however, that policy guided by macroeconomic analysis has
helped make the economy more stable.
Long-Run Economic Growth
Loig-rui ecoiomic growth is the sustained upward trend in the economy’ts output over
tme. Real GaDP per capita, is a measure of total output per person. Two points worth
notng: 1) oong-run economic growth is a modern inventon. 2) Countries don’tt necessarily
grow at the same rate. oong-run economics growth is crucial for many economic concerns,
such as a higher standard of living or fnancing government programs. It’ts especially crucial
for poorer countries.
Inflation and Deflation
Iiflatoi: a rise in the overall level of prices. deflatoi: a fall in the overall level of prices.
The Causes of Inflation and Deflation
In the short run, movements in infaton are closely related to the business cycle (Ch. 23). ->
When the economy is depressed, and cobs are hard to fnd, infaton tends to fall; when the
economy is booming, infaton tends to rise. In the long run, the overall level of prices is
mainly determined by changes in the money supply, the total quantty of assets that can be
readily used to make purchases.
The Pain of Inflation and Deflation
Both infaton and defaton can pose problems for the economy. Two examples: 1) Infaton
discourages people from holding onto cash, because cash loses value over tme if the overall
price level is rising. In extreme cases, people stop holding cash altogether and turn to barter.
2) DPefaton can cause the reverse problem. If the price level is falling, cash gains value over
tme. Soo, holding onto to it can become more atractve than investng in new factories and
other productve assets. This can deepen a recession.
In general, economists regard price stability – when the overall level of prices changes
slowly or not at all – a desirable goal.
International Imbalances
An opei ecoiomy is an economy that trades goods and services with other countries.
A country runs a trade defcit when the value of goods and services bought from foreigners
is more than the value of goods and services it sells to them. It runs a trade surplus when
the value of goods and services bought from foreigners is less than the value of goods and
services it sells to them. Reality is that there is no simple relatonship between the
success of an economy and whether it runs trade surpluses or defcits. What determines
whether a country runs a trade surplus or defcit? The determinants of the overall balance
between exports and imports lie in decisions about savings and investment spending (Ch 33).
-> Countries with high investment relatve to saving run trade defcits Countries with low
investment spending relatve to savings run trade surpluses.
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,Chapter 22 – GDP and the CPI: Tracking the
Macroeconomy
The National Accounts
Almost all countries calculate a set of numbers known as the iatoial iicome aid product
accouits, often referred to as the iatoial accouits, they keep track of the fows of money
between diferent sectors of the economy.
Following the Money: The Expanded Circular-Flow diagram
Figure 22-1 An Expanded Circular-Flow DPiagram: The Flows of Money Through the Economy
Sopending on goods and services – fows of money into the markets for goods and services –
comes from four distnct kinds of buyer:
1. Gaovernments: Goverimeit purchases of goods aid services are total expenditures on
goods and services by federal, state, and local governments.
2. Households: Coisumer speidiig is household spending on goods and services
3. Firms: Iivestmeit speidiig is spending on productve physical capital – such as
machinery and constructon of buildings – and on changes to inventories.
4. Rest of the world: Exports are goods and services sold to other countries.
Imports are goods and services purchased from other countries, they lead to a fow of
money out of the market.
Gross Domestic Product
Fiial goods aid services are goods and services sold to the fnal, or end, user.
Iitermediate goods aid services are goods and services – bought from one frm by another
frm – that are inputs for producton of fnal goods and services.
3
, Gross domestc product, or GDP, is the total value of all final goods and serviees
produced in an economy during a given period, usually a year. One way to calculate GaDP
is to calculate it directly: survey frms and add up the total value of their producton of fnal
goods and services. A second way to calculate GaDP is to add up aggregate spending on
domestcally produced fnal goods and services in the economy. -> aggregate speidiig, the
sum of consumer spending, investment spending, government purchases of goods and
services, and exports minus imports, is the total spending on domestcally produced fnal
goods and services in the economy. A third way of calculatng GaDP is to sum the total
factor income earned by households from frms in the economy.
Calculating GDP
Figure 22-2 Calculatng GaDP
Measuring GDP as the Value
of Production of Final Goods
and Services
The frst method for calculatng GaDP is to
add up the value of all the fnal goods
and services produced in the economy –
a calculatng that excludes the value of
intermediate goods and services. ->
Because countng the full value of each
producer’ts sales would cause us to count
the same items several tmes and
artfcially infate the calculaton of GaDP .
The way to avoid double-countng is
to count only each producer’ts value added in the calculaton of GaDP : the diference between
the value of its sales and the value of the intermediate goods and services it purchases from
other businesses.
Measuring GDD as Spending on Domestically Produced Final
Goods
Another way to calculate GaDP is by adding up aggregate spending on domestcally produced
fnal goods and services. -> GaDP can be measured by the fows of funds into frms. This
measurement must also be carried out in a way that avoids double-countng. We count
only value of sales to final buyers such as consumers, frms that purchase investment goods,
the government, or foreign buyers.
Measuring GDP as Factor Income Earned from Firms in the
Economy
A fnal way to calculate GaDP is to add up all the
income earned by factors of producton from
frms in the economy – the wages earned by
labor; the interest paid to those who lend their
savings to frms and the government;
dividends, etc. It is important to keep in
mind that all the money spent on domestcally
produced goods and services generates factor
income to households.
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