All Terrain Thinking

A Compendium of things I think are Important

Economics: It's not just whats' in your wallet

1. In macroeconomics we tend to focus our attention on business cycles-short term fluctuations in the economy. But what about the cycles in attitudes towards public policy, views in the self-adjustment powers of the economy, and the economic 'crises' that have produced these cycles. Please explain the parallel movements in economic policy, economic theory, and economic performance.

2. The stock market is hot. But will it stay hot-or can we expect it to fall? We will talk about these later, but for now I would like you to describe to me the impact on the macroeconomy of a dramatic fall in the stock market. How will it affect aggregate demand?

3. Now that you have been able to identify the consequences of the fall in the value of stock, its time to look beyond the immediate impact. Please use the simple model, and maybe even the appropriate graph, to explain the long-term consequences of the initial shock to aggregate demand. Be sure to consider the use of that old favorite-the multiplier-in your answer.

4. Forecasting is always difficult-especially when it is for the future. It made sense when I first heard it. But can we forecast? Can we anticipate? Let's try. Please use the 'model' we discussed in class to explain the impact of the following possible headlines.

• a. "Japan emerges from a long recession"
• b. "Fed decides to raise interest rates"

5. Tax policies have been a favorite of policy makers since the early 1960s. There is no question it makes sense-but do they work? Do they get you votes and do they affect the economy? What you will find is that they do not all work, but we have learned much along the way. Just as the space industry learned from Challenger, we learn from our mistakes/oversights. Please tell me what we 'learned' in the 1968 tax surcharge and the 1975 tax increase.

6. What is the impact of changing interest rates? This seems like a reasonable question as we listen to all the press about the consequences of government (FED) policies designed to fine-tune the economy. In the book you read that investment spending is affected by interest rates. Now its time to see where they get that idea. Please use the mortgage calculator to determine the monthly payment on a $100,000 mortgage for 30 years if the interest rate rises from 7% to 9%. Given what you see happen to the monthly payment, would you expect expect demand for new homes to rise or fall?

7. What is the proper role of the government? You are seeing this hotly debated in the press and at the ballot box. When was the last time being a 'tax-and-spend liberal was politically correct? Please try to briefly explain the relationship between the multiplier and the tax-and-spend liberal philosophy.

8. What would you do if you were an advisor to the president and the economy took a nose-dive-unemployment was running at 25 percent of the labor force, investment spending was down over fifty percent, and people were moving away from the cities to try to make a go of it by moving back to the farms. Would you attempt to balance the government budget?

1. Use the income-expenditure diagram to demonstrate the impact of income on:

• a. an increase in interest rates that lower investment spending
• b. a decrease in consumption spending
• c. a decrease in the savings schedule
• d. a reduction in consumer confidence
• e. a decline in interest rates
• f. a tax cut to consumers
• g. a reduction in national wealth
• h. accelerated depreciation
• i. import quotas

2. Assuming the following output-income and saving data for the private sector of the economy, calculate the consumption schedule and answer the following questions.

Aggregate Supply (GNP)	Saving	Consumption
$250	$-10
$275	$-5
$300	$0
$325	$5
$350	$10
$375	$15
$400	$20
$425	$25
$450	$30

• a. Assuming investment, is $5 billion and independent of the level of GNP, what will be the equilibrium level of GNP?
• b. Assuming investment spending is $15 billion and independent of the level of GNP, what will be the equilibrium level of GNP?
• c. Why is $400 (GNP) not an equilibrium? Describe what will happen to move the economy to equilibrium.
• d. What is the value of the MPC? The MPS?
• e. Based on your experiments in this problem, it should appear as though a change in investment spending has a multiplier effect on income. Tell me how much income should change for a one unit change in investment spending.

3. As a policy maker would you want an economy to have a large or small multiplier? Explain briefly.

4. Please explain why the Kennedy tax cut was far more successful at achieving its goal than the Johnson surtax.

5. Consider the following simple algebraic model of a macro economy:

• a. Represent this economy in a circular flow diagram when income (Y) is 2000. Do we have an equilibrium at this level of income. If not, tell me what is happening to inventories and the likely direction of change in the economy.
• b. Calculate the equilibrium level of income.
• c. Calculate the government multiplier.
• d. Calculate the tax multiplier.
• e. How much would private investment have to change to move the economy from its initial equilibrium (part b.) to 3000.

6. The debate over the value of discretionary monetary and fiscal policy is likely to intensify in the upcoming years. Every economist, however, would likely agree that automatic stabilizers are valuable. In this example, you are going to be asked to demonstrate the influence of automatic stabilizers as the economy's cyclical properties. The model of the economy is presented below:

The equation for taxes is missing because I want you to consider two tax policies. The first assumes a constant lump sum tax of 100. The second assumes that tax revenues are dependent on income (ex. income tax). The relationship is T = 10 + .1Y. You are to use some computer package that will allow you to perform some simulations of this model. The economy is initially in equilibrium which in a dynamic model means that income is constant (Y = Y-1 = Y-2).

• a. Solve for the equilibrium level of income.
• b. Calculate Y and D and the deficit for fifteen years after you allow for a permanent increase in autonomous investment of 50 in year 3.
• c. Construct time series graphs of Y, D, and the deficit and briefly describe the differences between the two models.

1. Are we ready for a little more complication in your macro model? One reason to do it is that it allows us to help explain the emergence of Ronald Reagan on the national political scene. He seized the moment, he identified the 'wave' of public sentiment and rode it into the White House. What was it that Ronald Reagan offered the solution to? What were the problems that the American people believed he would solve? What did he do? Please demonstrate the situation with AS-AD diagrams.

2. And how did he propose to solve it? Identifying the problem is only half the battle. What can we do to solve the problem? What was the name given to his 'package' of reforms designed to right the course of the American economy? Please use the diagrams from class to demonstrate the Reagan solution to our problem.

3. One last question on Reagan. What were the 'pieces' of his economic package and how did they all work together to form a complete solution?

4. Please explain the significant differences between the inflation caused by the military buid-up for Vietnam in the late 1960s and the inflation caused by the OPEC price increase in the early 1970s.[you may want to use the AS-AD model]

Unit Index

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