ECON-301
DR. KELTON
                                                            REVIEW TOPICS FOR MIDTERM #1

GROSS DOMESTIC PRODUCT AND THE ECONOMY

    - There are four "sectors" in the economy.  What are they?
    - How do we define a household?
    - How is the labor force defined?
    - How is the unemployment rate measured?
    - Do measured (i.e. official) unemployment rates probably over-estimate or under-estimate the true extent of the problem? Why?
    - The government sector can be divided into two levels of government. What are they?
    - Define gross domestic product (GDP).
    - Define gross national product (GNP).
    - Why is it so important to emphasize the word "final" in these definitions?
    - What is the difference between a "final good" and an "intermediate good"?  Give an example of each.
    - When governments make "transfer payments", they are not counted as government spending.  Why not?
    - Why do we include (X - M) in the GDP equation? 
    - What does (X - M) measure?
    - When does a nation have a trade surplus? A trade deficit?
    - What does the circular flow diagram show?
    - Does it imply Say's Law?  Explain.
    - Write down an equation for GDP.
    - Which component of GDP is the largest?
    - Is GDP a good way to measure a country's "health" or economic well being?  What are some of its shortcomings?
    - What is the difference between nominal and real GDP?  Which is a better measure of well-being?  Why?
    - What is the GDP deflator?  Be sure you can use it to convert nominal GDP to real GDP.
    - What does per-capita real GDP tell you?  Is it a better measure of well-being than real GDP?  Why?

THE (NEO)CLASSICAL MODEL

- According to the Classical Model, how is the level of aggregate employment determined?  Explain this very carefully!
- How is the level of aggregate output determined?  Carefully explain!
- How is the aggregate price level determined?  Thoroughly discuss! 
- How is the aggregate level of savings determined?  Aggregate investment?  Write your answer in essay form.
- What determines "the" interest rate?  Explain carefully?
- What is Say's Law?  Be careful!
- Does the Classical Model accept or reject Say's Law? Explain.
- If households decide to spend less (i.e. save more), will this cause output to fall and unemployment to rise?  Explain very carefully.
- Explain why the Classical Model describes the workings of the economy from a supply-side perspective. 
- In this framework, what would happen if the monetary authority tried to stimulate production by increasing the money supply?  Explain carefully and show graphically.
- In order for growth (in output) to occur, one of three things must happen.  What are they?
- Will a change in prices, money, government spending or investment spending affect output in the short-run? Explain.
- Why is the Classical Aggregate Supply Curve vertical in the short-run? Explain carefully.
- Given the vertical aggregate supply curve, what is the effect of an increase in aggregate demand?
- What are the policy implications of the ‘Classical’ Model?
- Does output automatically adjust to full employment in the Classical Model? Explain.

THE KEYNESIAN SYSTEM

- What did Keynes’ theory have to do with the Great Depression?
- What does capacity utilization mean?
- What determines the degree of capacity utilization in the Keynesian Model?
- What do we call the model that represents Keynes’ ideas?
- What does the Keynesian AS curve look like? What do all points along this line indicate?
- What did Keynes call the functional relationship between income and consumption?
- What is the Marginal Propensity to Consume (MPC)?
- Write down a formula for disposable income.
- Write down a formula for the simple (i.e. closed-economy with no government) spending multiplier.
- Write down a formula for the open-economy spending multiplier.
-What is potential output? Define.
- Define the GDP gap.
- Define the recessionary gap.
- Which component of GDP did Keynes consider a stable function of income?
- Why did Keynes consider Investment the most volatile component of AD?
- What determines the slope of the AD curve?
- What happens when aggregate expenditure and aggregate output differ in this model?
- When aggregate expenditure = aggregate output, we can say that "injections equal leakages". Write an identity showing injections equal leakages in an open economy with a government.
- Why does an increase in one of the components of AD cause output/income to increase by more than the initial increase? (e.g.why does a $10 billion increase in investment spending (ultimately) lead to a larger increase in total output/income?)
- Derive the Keynesian (spending) multiplier.
-Write down an equation for the tax multiplier.
- Why is the value of the tax multiplier always negative?
- Be sure you can use the tax multiplier to calculate the effect of a change in T.
- Will the tax multiplier be larger or smaller (in absolute terms) than the spending multiplier? Why?
- If the government raises taxes by $100 and then spends this $100 itself, will there be any change in GDP? Explain.
- What are the policy implications of the Keynesian model?
- Does output automatically adjust to full employment in the Keynesian system? Explain.
- What was the Keynesian explanation for massive unemployment in the Great Depression?
- How did Keynes think fiscal stabilization could be used to combat the situation? (explain fiscal stabilization and its potential uses.)

MONEY AND INTEREST RATES

• Keynes identified three motives for holding money. List and describe each. What economic variable influenced each?
  Is money the same thing as liquidity (define)?
• Keynes's Liquidity Preference Function can also be considered a money demand function. Explain what it shows.
• In some frameworks (e.g. the Classical Model), money is "neutral". What does this mean?
• Is money a stock or a flow concept? What is the difference?
• According to Loanable Funds Theory, how is the interest rate determined? Explain carefully.
• Is Loanable Funds a stock or flow theory of the rate of interest? Why?
• Loanable Funds considers the rate of interest a reward for doing what?
• If government competes for loanable funds (i.e. adds to the total demand for L.F.), this will "crowd out" some private investment spending. Carefully explain how/why this occurs.
• Will government borrowing in the loanable funds market cause an increase in aggregate demand and a bidding up of the price level? Explain your answer carefully.
• What if the government prints new money to finance its spending instead of borrowing money in the LF market? Will this affect price level? Explain!
• According to Liquidity Preference Theory, how is the interest rate determined?
• Is Liquidity Preference a stock or flow theory? Why?
• What role does money play in the Classical framework?
• What role does money play in the Keynesian framework?
• According to the Classical Model, how will an increase in the money supply affect the macro economy?
• How does an increase in the money supply affect the macro economy in the Keynesian framework?
• Liquidity Preference considers the rate of interest a reward for doing what?
• How did Keynes explain the relationship between the rate of interest and the level of investment spending?

CONSUMPTION AND INVESTMENT

• Write down a formula for the average propensity to consume (APC).
• Economists noticed something strange about the long-run behavior of the APC. What did they notice, and why was it considered puzzling (or strange)?
• List and carefully describe three attempts to explain the observed behavior of the APC.
• Which economist is associated with each theory? Which were received the Nobel Prize?
• What do the LCIH and PIH implicitly assume about lifetime saving patterns?
• What is the accelerator model?
• How does the accelerator story help economists explain growth and cycles?
• How does the simple accelerator model differ from an accelerator model with lags? Which model is supposed to be more realistic? Explain.