4) Determine whether each of the following is a positive or normative statement.
a. The Bank of Canada should lower interest rates to increase economic growth, because we're in a recession.
b. Higher government budget deficits cause higher interest rates.
c. The trade deficit should decline because of the fall in the value of the dollar.
d. Because of our high inflation rate, we must reduce the rate of money growth.
e. A generous unemployment insurance system is a primary cause of high unemployment in Europe.
f. Increased average labour productivity in a country should lead to faster growth.
g. Government budget deficits are too high in Canada and should be reduced.
Answer:
a. normative
b. positive
c. positive
d. normative
e. positive
f. positive
g. normative
Diff: 2 Type: ES Page Ref: Sec. 1.3
5) Discuss the major difference between classical and Keynesian economists. Be sure to explain how they differ with regard to how quickly equilibrium is restored in the economy as well as what role they see for government action in restoring equilibrium.
Answer: Classical and Keynesian economists differ most with regard to how quickly they see wages and prices adjusting to restore equilibrium in the economy. Classical economists think that when the economy is out of equilibrium, wages and prices adjust quickly to restore equilibrium. As a result, there shouldn't be long periods of abnormally high unemployment. The quick return to equilibrium means there is no reason for government action. Keynesians, on the other hand, think wages and prices are slow to adjust. As a result, the economy may be out of equilibrium for some time, perhaps with high unemployment. To restore equilibrium quickly may necessitate some government action, such as increasing the government's demand for goods and services.
Diff: 2 Type: ES Page Ref: Sec. 1.3
6) Describe what the two key assumptions are in the "invisible hand" idea.
Answer: The first assumption in the invisible hand idea is that people pursue their own economic self-interests. The second key assumption is that the various markets in the economy must function smoothly and without impediment. In particular, it is assumed that wages and prices are fully flexible and must adjust rapidly enough to maintain equilibrium in all markets. If there is a disequilibrium, the prices and wages would adjust quickly to restore the equilibrium.
Diff: 2 Type: ES Page Ref: Sec. 1.3
7) You are asked to analyze the effect of the Bank of Canada's new interest rate policy on housing prices. Using a comparative static experiment, describe the steps you need to follow to produce a sound theoretical macroeconomic analysis.
Answer: First, we need to set up a macroeconomic model that includes all relevant variables and is assumed to be in equilibrium. Second, we change the interest rate, keeping all other variables constant, and examine the change in housing prices. Third, we observe how our macroeconomic model responds to the interest rate changes.
Diff: 2 Type: ES Page Ref: Sec. 1.2
8) Explain what Keynes meant by the phrase "in the long-run we are all dead."
Answer: Keynes argued that wages and prices will eventually adjust to equate demand and supply, but this adjustment might be slow to occur. Therefore, the phrase makes the point that it might not be good government policy to wait for that eventual adjustment in wages and prices. He therefore proposed that governments take actions to alleviate the unemployment resulting from the slow adjustment of wages and prices.
Diff: 2 Type: ES Page Ref: 12
9) Explain the main assumptions in a balanced and unified approach to macroeconomics.
Answer: The balanced and unified approach to macroeconomics has the following characteristics:
1. Individuals, firms, and the government interact in goods markets, asset markets, and labour markets.
2. The model's macroeconomic analysis is based on the analysis of individual behaviour.
3. In the long term, prices and wages fully adjust to achieve equilibrium in the markets for goods, assets, and labour.
4. The basic model may be used with either the classical assumption that wages and prices are flexible or the Keynesian assumption that wages and prices are slow to adjust.