March 1- March 26

March 1

Q1: The consumption function is a long formula. I'm pretty sure I will get lost in the whole problem when trying to figure it all out.

A: With the consumption function you have three variables with only one unknown value.

                  C = a + bYd

You are given a, b and Yd. You then solve for C. For example:

                                 b = .75, a = 50

                         Yd     a      C           S             Solution

                        100    50    125        -25         C = 50 + .75(100)

                        200    50    200          0          C = 50 + .75(200)

                        300    50    275       +25         C = 50 + .75(300)

So, the consumption function is straightforward. The next problem is to find the point where Yd = C. You can stumble onto it as I did above (Yd = 200 is where C=Yd). But that was just dumb luck. The way to do this without relying upon luck is to set C equal to Yd, which means setting Yd = a + bYd, right? Like this:

                              Yd = a + bYd   or using the figures for a and b above:

                        Yd = 50 + .75Yd

Now, we still have only three variables (a, b, Yd) with only one unknown (Yd). The trick is to clear Yd from the right side, like so:

                       Yd - bYd = a    or

                      Yd (1-b) = a       or   

                      Yd = a/(1-b)       now convert a and b to their given values:

                      Yd = 50/(1-.75)   which equals

                      Yd = 50/.25 = 50 x 1/.25 = 50 x 4 = 200

That's the disposable income where consumption is just equal to disposable income, i.e., people are spending everything they earn on consumer goods and saving nothing. 

Q2: Out of curiosity, what is the time line of Marx's and keynes' theories on economics?

A: Marx wrote the first volume of Capital in 1867 and was long dead when the final volume of Capital was published in 1894 (His collaborator, Fredrich Engels, continued to edit and publish Marx's manuscripts long after his death). Marx died in 1883, coincidently the very year that John Maynard Keynes was born. Keynes published The General Theory of Employment, Interest and Money in 1936. The Great Depression appeared to have proved Marx's theories correct and World War II, which began in 1940 (for the U.S.), seemed to prove Keynes correct -- that massive amounts of spending by the government can drive an economy to higher levels of employment and production.  

Q3: What is induced spending?

A: Autonomous spending occurs as consumers suddenly, through perhaps an increase in consumer confidence, increase spending as a percentage of income. Induced spending is spending that arises as a result of increases in income. 

Q4: What was the answer to e) on the in-class exercise?

A: If Alan Greenspan announced that the unemployment rate would rise to 10% in the next six months, consumer confidence would plunge and people would begin to cut spending and increase savings. The result could be a self-fulfilling prophesy -- peoples' reaction to Greenspan's comment would cause the result he predicted. That's why Federal Reserve Chairman are careful when they speak. Economists are like tea leaf readers when they listen to his words.

Q5: How does Keynes' theory of government spending go back into the value of goods?

A: You have to imagine the circular flow of income and spending. Goods are produced, which generates income to those who participated in their production. That income is taxed and government spends that money for some of the goods and services that have been produced.

March 3

Q1: What was Keynes' famous Quote?

A: There were a number of them. One was "In the long-run we're all dead".

March 15

Q1: I think a major problem with studying for your exams is that we feel we understand the notes, and the notes are not similar to the book or the exam questions. Personally, I'm having a lot of trouble understanding the lectures as you speak very quickly and sporadically through terms and ideas. It's very difficult to follow the lesson! This is a lot of new material for everyone and the further behind the class falls, the more you feel the need to speed through the chapter. I am having trouble keeping up with chapter topics and I'm definitely not retaining the material! What do you suggest? I know many other people are feeling the same way!!! I also think the in-class exercises are good study guides --> so please give more time for them!!

A: Wow. A lot of exclamation points. I want to take your concerns seriously, but I also want to caution against exaggeration. My notes are both presented in class and available on the website. The notes follow the text topics. The exam questions are taken directly from the notes. The study guide, which was also available on-line as well as being presented in class, was a replica of the exam. I take a lot of time answering student's questions on the comment cards and putting them on the website. I have offered my time to students who want to form study groups.

It is important to consider how you study, work on the homework and prepare for the exams. Yes, terms and concepts presented in economics are new to most of the students -- although I had a comment card from someone in the early part of the course which stated that they had this class in high school and knew all these concepts. Paul Samuelson, the original developer of the modern college courses of macroeconomics and microeconomics, wrote once, "economics is beset by a tyranny of words". I agree, but there is only one way to address the task and that is to rigorously pursue the meaning of each new concept with the purpose of being able to apply them in the appropriate way. An example like the real GDP gap could be used to illustrate this approach. First, understand it is the difference between equilibrium GDP and the GDP that will fully employ the labor force (full employment GDP). On the diagram of aggregate demand and aggregate supply, the equilibrium point is where the two curves intersect. That's where the amount of aggregate spending is just enough to clear the market of all the goods produced. But full employment GDP might be at a higher level, hence there will be a certain amount of unemployment; or it might be at a lower level and that would result in an inflationary condition. Ask yourself why that is -- if full employment GDP is above the equilibrium GDP and producers collectively produced at the full employment level you can see that aggregate supply is greater than aggregate demand. Producers will not continue producing at a level that exceeds the level of demand for output -- they will lay off workers and cut production. Draw the diagrams. Practice measuring the distance between full employment GDP and equilibrium GDP. Check the textbook for diagrams that depict the same relationships and review the explanation in the text and in your notes. Now, if your understanding is still shaky, frame questions around your confusion. Ask a lot of questions. Never go beyond a passage in the text that you don't understand without writing a comment or question in the margin. Never let me get away with a statement in class that is not clear to you. Shoot up your hand and ask a question. Beat me over the head with the textbook if that helps.

I appreciate your comments. You are addressing the right concerns -- your difficulty with the material (and/or my presentation of it -- I admit my fallibility). Asking what you can do to understand this stuff is much better than to ask, "How do I get a better grade". This demonstrates that you are a serious student. Thanks.

Q2: Is it possible for the equilibrium of S=I to fall out of sync?

A: If you mean desired (or planned) I, then yes this can and does happen. In the simple Keynesian economy (no government or trade sector), the only unspent income (i.e., leakages from the income-consumption stream) would be savings and the only injections to offset that would be planned investment spending. But, as Keynes said, since the decision to save and the decision to invest are made by two different entities (consumers and businesses) it is possible for them to be out of sync. If S>I you have a recessionary condition (recessionary gap). If S<I you have an inflationary condition (inflationary gap).

March 17

Q1: Are savings interest earned and investment interest spent at all related to government spending? Or how are they related? I get them confused when you say "interest".

A: Remember, all of the forms of income are simultaneously costs to those paying them. Just as wages are both income to workers and costs to employers, interest is both income to those who receive it and a cost to those who pay it. If you own a government bond, then you earn interest income that the government pays to you. If you own a corporate bond, then the same is true -- the corporation has borrowed your money and is repaying the principal plus interest. Interest is a cost to the borrower and income to the lender. "Investment interest" is not a term I have used. When macroeconomists use the term investment they mean the money businesses spend to add on to plant and equipment.

Q2: Can you go over the diagrams [of aggregate demand and aggregate supply] again ...[and]...explain the difference between recessionary and inflationary gaps?

A: If full employment GDP occurs at a level of GDP that is higher than equilibrium GDP then there is a recessionary gap. On page 163 you'll see a diagram of a recessionary gap (Q_F is higher than Q_E). If full employment GDP occurs at a level of GDP that is lower than equilibrium GDP then there is an inflationary gap. On page 175, you'll see the affects of an increase in spending that results in a rightward shift of AD which closes a recessionary gap. Equilibrium GDP is now the same as full employment GDP -- we're at full employment. On page 189, figure 9.10c, you'll see an inflationary gap. That could be closed by either shifting AD back to the left (a decrease in spending) or shifting AS to the right (subsidizing business, reducing regulation, cutting corporate taxes) until the intersection point occurs at full employment GDP.

March 22

Q1: If you are not given what full employment is and you have an inflationary gap, then how do you solve excess AD to find full employment? (Is this even possible?) I gathered the question from figure 11.6 -- ch. 11, pg. 229.

A: You are given what full employment GDP is. The diagram shows that Q_F is $6 trillion and the current equilibrium GDP is $6.2 trillion with AD₁. Excess AD is the distance by which aggregate demand must be reduced to create equilibrium at full employment. The difference between point f and E₁ in figure 11.6 is excess demand -- in this case $400 billion ($.4 T.). So, spending has to fall $400 billion to reduce GDP by $200 billion. Why? Because some of that reduction in spending will only result in a fall in prices rather than a reduction in output (real GDP). If AS were a flat line (as Keynes assumed because he was concentrating on the Great Depression during which price changes were not the problem) then a $200 billion inflationary gap could be eliminated by reducing spending by $200 billion.

Q2: If the consumption function solves to find the amount consumed, do we need to particularly know the multiplier and how it works if it also calculates the amount consumed?

A: You'll need to know the multiplier when there is an autonomous change in spending (like a rise or fall in investment). Any change in spending -- other than that induced by a change in income -- has a multiplier effect. So, if investment rises by $20 billion and MPC is .75, equilibrium GDP will rise by $80 billion (4 x $20 b.).

Q3: I don't understand the change in C = 0 and change in S = $10 b. after change in I = $10 b. Why isn't change in S = 0 too?

A: When businesses decide to increase investment spending by $10 billion it means that at a certain level of GDP at which aggregate demand equals aggregate supply there is a sudden excess level of spending. As a result the capital goods industry hires more workers and pays them to produce more machines. That puts $10 billion of extra income into the pockets of all participants in the capital goods industry. If MPC is .80 these income recipients will spend another $8 billion and save $2 billion. This continues until the entire $10 billion is finally absorbed into savings. At that point there are no more rounds of re-spending possible. So, when it's all over, Investment spending is $10 b. higher, Consumption spending is $40 billion higher and savings is $10 billion higher. Notice, S = I again?

Q4: If Americans refused to buy products from corporations that laid off its employees in the U.S. then moved operations to another country, would the corporation heed Americans' demands or would they search for new markets?

A: First, it would have to be a very convincing boycott. During the 1970s Cesar Chavez, the head of the United Farmworkers Union, organized a national boycott of table grapes to pressure California growers to negotiate with his union. It worked because unions across the country mobilized to picket supermarkets carrying California grapes. But even that eventually collapsed as the growers settled a sweetheart contract with the Teamsters Union at much lower wages and benefits and Governor Ronald Reagan increased the demand for grapes by the State of California and convinced the Pentagon to increase its orders for grapes. There are powerful forces at work against those who would stand up to capital. Now, however, Congress is considering legislation to eliminate subsidies to corporations who close plants and move them offshore. Even a Republican congress recognizes that it doesn't make sense to give tax breaks to corporations who flee the country.

March 26

Q1: How can the Federal government (the White House) even consider making fast food jobs count as manufacturing jobs?

A: This isn't likely to occur. Once a decision like this is made public, the administration quickly backs down. It's too embarrassing. But if they could have done it without it getting in the press, they would have been able to tell the American public that unemployment had fallen in manufacturing. This is reminiscent of the Reagan administration trying to argue that catch-up was a vegetable in order to reduce the cost of school lunch programs.