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Learn the basic idea behind Keynesian Economics and how it aims to manage demand to achieve a full employment equilibrium. Explore the concepts of fiscal policies, GDP, investment sector instability, and the impact of fear on investments.
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1. What is the basic idea behind Keynesian Economics? a. If we let the natural adjustments to take place the economy will repair itself. b. Because the economy is always tending toward a full employment equilibrium we should let the economy correct any malfunctions itself without government intervention. c. When the economy is tending toward a less than full employment equilibrium we should use our discretionary fiscal policies to push the economy to a full employment equilibrium. C. Fiscal policies can shift the aggregate demand curve to the right and thus shift the equilibrium to full employment.
2. The idea behind Keynesian Economics is that if we can manage demand we can manage the economy. True By managing demand using our discretionary fiscal policies it was thought that we could manage the economy and guide it to a full employment equilibrium.
3. Because of the Keynesian successes during the 1930s and the 1960s we know now that we can control the economy by controlling demand. False When stagflation hit us in the 1970s we learned that because the problem was a supply problem we could not solve it with demand remedies.
4. Which of the following is an example of a leakage? a. Banks lend money out a business owner. b. Foreigners buy U.S. products. c. People put their savings in a bank. C. When money leaves the income stream, that is it no longer circulates, we call it a leakage.
5. Which of the following is an example of an injection? a. Foreigners buy U.S. products. b. People put their savings into a bank. c. People pay their taxes. A. When foreigners buy U.S. products money flows into our income stream, we thus call it an injection.
6. Gross Domestic Product (GDP) is defined as the market value of all a. resources produced in one year by U.S. firms. b. final goods and services produced in one year by all resources located in the U.S., regardless of who owns these resources. c. final goods and services produced in one year in the U.S. by resources owned by U.S. citizens. B. This is the official definition of GDP.
7. What makes the investment sector so unstable? a. It is the largest sector of GDP. b. It takes time to decide what to do about an investment. c. Decisions are based on expectations of what investors think is going to happen in the future. d. all of the above. C. Because decisions are based on expectations and because so many things can influence expectations, the investment sector tends to be unstable.
8. Fear and uncertainty are the twin killers of investment. True Because investments are based partly on future expectations doubt and fear of what might happen will put a tamper on investments.
9. A decrease in interest rates will lead to an increase in investments. False The answer is false because it is not true all of the time. If expectations are very negative, then a decline in interest rates may not be sufficient to spur on investments, but we say that everything else is equal, then a decline in interest rates should lead to an increase in investments.
10. Which of the following is an example of the acceleration principle? a. The bank lends out money and the borrower buys something with the money. b. Apple invents a new product and Best Buy increases its’ sales volume. c. The state builds a new highway and as a result several gas stations are built along the highway. C. The acceleration affect takes place due to induced investments. The gas stations were induced from the investment of building the highway.
11. Conditions during the Great Depression of the 1930s were fertile ground for the ideas of John Maynard Keynes, and the age of demand management economics was born. True During the 1930s the economy was in a deep depression and President Franklin Roosevelt supported the ideas of deficit spending and an enlargement of government programs, both of which supported the ideas of Keynesian economics.
12. The Employment Act of 1946 committed the federal government to ensure maximum employment, production, and purchasing power. True The Employment Act of 1946 represented the first time that the federal government codified into law its responsibility to achieve full employment by way of active fiscal policies.
13. By the 1960s most economists embraced the ideas of Keynes and believed in demand management economics. True The 1960s was a decade when the ideas of demand management economics favored by Keynes became widely accepted by academia and Washington DC.
14. Because of the unusually long economic expansion from 1961 to 1969, fine tuning of the economy was widely accepted. True Nothing succeeds like success, or so it appears. The expanding economy during the 1960s helped solidify the dominance of Keynesian economics both in Washington DC and at most of the mature universities in the nation. Harvard University became the leading university supporting the Keynesian philosophy with the University of Chicago being one of the few universities supporting Austrian economics.
15. Consumer demand for durable goods tend to be more stable than the demand for nondurable goods. False A durable good is a good that lasts for a long time, like an automobile. A nondurable good lasts for a short time, like food. When consumer’s expectations change or their incomes change, purchases of nondurables will not change very much, but the demand for durables will change a lot.
16. When you withdraw money from savings economists say that you have dissaved. True Savings is the act of putting money into savings, dissaving is the act of taking money out of savings.
17. A cornerstone of Keynesian economics is the belief that without government borrowing money can get trapped in banks and not circulate in the economy where the money is needed. Keynes called this a liquidity trap. True The belief in the liquidity trap is a main reason why Keynesian economics was accepted by academia. If banks could not lend out enough money to consumers and business, then it was up to the federal government to borrow the money and inject it into the income stream.
18. The investment sector of the economy tends to be very unstable, whereas the consumption sector tends to be very stable. True The consumption sector is very stable because consumers tend to be very habitual. When events change, their actions do not change right away. Because of savings and dissavings consumers will maintain their previous spending habits, at least for awhile. But because investors make their decisions based on their expectations of future events, any change that will cause them to be more pessimistic or optimistic will have a profound effect on the level of investments.
19. Along with the concept of a liquidity trap, the Keynesian multiplier is the second biggest reason why economists and politicians support Keynesian economics. This is what economists call the “balanced budget multiplier.” True The idea that that a dollar in the hands of the government has a greater stimulative impact on the economy then that dollar in the hands of individuals garnered wide spread support for increasing the national debt and increasing government spending.
20. The belief in the balanced budget multiplier has led to huge increases in government borrowing and spending since the 1960s. True The balanced budget multiplier recognizes that when individuals have a dollar they will spend most of it, but save some of it. But, when the government has the money, it will spend all of it. Therefore, there is a larger multiplier effect on the economy when the government has the dollar instead of individuals.
True Because Austrian economists extoll the ideas of savings and investing to grow the economy, they believe that a dollar in the hands of government will be spent on programs that may be politically motivated, but not conducive to economic growth over the long term. Austrian economists also debunk the idea of the liquidity trap because they believe that the free market will drive down interest rates during recessions, giving investors more incentive to borrow and invest. 21. The concepts of the liquidity trap and the balanced budget multiplier are debunked by Austrian economists.
22. Big tax breaks for the first time home buyers have a positive impact on the economy and lead to an increase in home ownership and more jobs over the long run. False Both Austrian and Keynesian economists recognize that consumers make most of their decisions based on their expectations of future income, not necessarily on their present income. If people expect a large income tax return, they will tend to increase their present spending in anticipation of that future income. Likewise, if consumers are pessimistic about the future, they will tend to curtail their spending, regardless of their present income.
23. Lag effects can be a cushioning effect on the economy in the short run but can cause wider swings in the business cycle over the long run. True Because it takes time to recognize there is a problem, to make a decision of what to do about the problem, and to put into action the agreed upon remedy, months or even years may go by. In the short run these lag effects may cushion any wide swings because they temper any radical short run changes. However, in the long run they can be a destabilizing force because events can change radically between the time that the problem was recognized and when the proposed solution takes effect.
True A pro-cyclical policy is a policy that accentuates the wide swings of the business cycle. A counter-cyclical policy would be a policy that tempers the wide swings of a business cycle. In a perfect situation with perfect control and knowledge monetary and fiscal policies would be counter-cyclical. But because we live in a democracy and because our knowledge is not perfect, we experience lag effects anytime a change occurs. These lag effects can work at cross purposes to our intentions. 24. Monetary and fiscal policies tend to be pro-cyclical because of lag effects.
25. Austrian economists tend to support the Full-employment and Balanced Growth Act of 1978. False The idea that the government can take action to ensure full employment and stable prices is the antithesis of Austrian economics. Austrians tend support policies that ensure a level playing field and a flexible economy fueled by market forces. Keynesians would more likely support a larger role of the federal government in their belief that as long as we can control demand we can control the economy.
