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Solution Manual for Economics 5th Edition By Paul Krugman, Robin Wells. A+
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Practice questions + Answers - Chapter 21-30 - Economics 2 for IBA
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Economics 2 summary – by Lynouk van HasselMacroeconomics
Chapter 21: Macroeconomics: The big picture
Macro vs Micro
➢ Microeconomics focuses on how decisions are made by individuals and firms and the
consequences of those decisions.
▪ See table 21-1 page 598 for examples.
➢ Macroeconomics examines the overall behaviour of the economy, how the actions of all the
individuals and firms in the economy interact to produce a particular economy-wide level of
economic performance.
o A key insight: the combined effect of individual decisions can have results that are
very different from what any one individual intended, results that are sometimes
perverse.
o The behaviour of the macroeconomy is, greater than the sum of individual actions
and market outcomes.
o Questions within macroeconomics is concerned about policy -> what can the
government do to perform better.
Self-regulating economy: Problems such as unemployment are resolved without government
intervention, through the working of the invisible hand.
Keynesian economics: Economic slumps are caused by inadequate spending and they can be
mitigated by government intervention.
o Government intervention can help a depressed economy through:
▪ Monetary policy: Uses changes in the quantity of money to alter interest
rates, which in turn affect the level of overall spending.
▪ Fiscal policy: Uses changes in taxes and government spending to affect
overall spending.
Paradox of thrift: The reduction in spending depresses the economy as the consumers spend less
and businesses react by laying off workers. This is a paradox because seemingly virtuous behaviour,
preparing for hard times by saving more, ends up arming everyone.
The business cycle: The short-run alternation between recessions and expansions.
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© 2019, Lynouk van Hassel. All rights reserved.
, ➢ Recession: (contractions) are periods of economic downturn when output and employment
are failing. A broad-based downturn, in which output and employment fall in many
industries.
o Periods when GDP (a measure of overall output) and employment do badly -> in the
US declared by NBER.
➢ Expansions: (recoveries), are periods of economic upturn when output and employment are
rising. When economy is not in a recession.
➢ Business-cycle peak: the point at which the economy shifts from expansion to recession
➢ Business-cycle trough: the point at which the economy shifts from recession to expansion.
Long-run economic growth: the sustained upward trend in the economy’s output over time.
❖ Growth is about the long-run. Business cycles are about the medium term.
o But business cycles are important:
▪ Recessions go hand in hand with increasing unemployment, people lose jobs
and have a hard time finding new jobs -> a lot of distress
❖ Small differences in growth rates can have important consequences after a while (cfr
compound interest).
❖ It dominates in the long-run with business cycles
❖ Two points:
o Lon-run economic growth is a modern invention
o Countries don’t necessarily grow at the same rate.
▪ See page 606
Inflation and deflation
➢ Inflation: a rise in overall level of prices
o When the economy is depressed, inflation tends to fall, when the economy is
booming, inflation tends to rise.
o Inflation discourages people from holding onto cash, cash loses value if the overall
price level is rising. The amount of goods and services you can buy with a given
amount of cash falls. In extreme cases, people stop holding cash and turn to barter.
➢ Deflation: a falling in overall level of prices
o If the price level is falling, cash gains value over time. The amount of goods and
services you can buy with a given amount of cash increases. Holding on to it can
become more attractive than investing in new factories and other productive assets.
This can deepen a recession.
Money supply: in the long run, the overall level of prices is mainly determined by changes of money
supply.
Price stability: the overall level of prices is changing, if at all ,only slowly, as a desirable goal.
Open economy: an economy that trades goods and services with other countries.
Trade deficit: the value of the goods and services bought from foreigners is more that 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 the goods and services it sells to them.
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© 2019, Lynouk van Hassel. All rights reserved.
, Chapter 22: GDP and the CPI: Tracking the macroeconomy
How to measure an economy? By comparing the value of their production.
National accounts
➢ It tracks spending of consumers, sales of producers, business investment spending,
government purchases etc.
➢ The national income and product account or national accounts: keep track of the flows of
money between different sectors of
economy.
The four markets of the circular-flow diagram:
1. Governments: has income through taxation
and borrowing (bonds).
a. They buy goods and services through
government transfers.
2. Households: income through factor markets
(wages). They own factors of production,
such as labour, land etc.
a. Consumer spending: household spending on goods and services
3. Firms: are financed through financial markets.
a. They engage in investment spending: spending on productive physical capital, such
as machinery and construction of buildings, and on changes to inventories.
4. Rest of the world: exports.
Imports leads to a flow of money out and exports leads to a flow of money in.
Gross Domestic Product (GDP) / nominal GDP
➢ It is the total value of all final goods and services produced in an economy in a given period,
usually one year.
o Final goods and services: goods and services sold to the final or end users.
o Intermediate goods and services: goods and services, bought from one firm by
another firm, that are inputs for production of final goods and services.
➢ What does it tell us:
o The size of the economy
o If you want to look at how rich a country is, you could look at GDP per capita.
o Be careful! Prices change over time, so GDP can go up only due to price changes.
➢ Three different ways to calculate the GDP:
o Adding up spending on all domestically produced goods and services:
▪ Aggregate spending: the sum of consumer spending, investment spending,
government purchases of goods and services, and exports minus imports, is
the total spending on domestically produced final goods and services in the
economy. GDP = C + I + G + X -IM
• C= consumer spending
• I= investment
• G= government purchases of goods and services
• X= exports
• IM= spending on imports
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© 2019, Lynouk van Hassel. All rights reserved.
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