ISL244E Macroeconomics Problem Session -1

1. ISL244E MacroeconomicsProblem Session-1 by Research Assistant Serkan Değirmenci (Ph.D. Candidate) D202/13.02.2012/15.02.2012

2. # Textbooks # • Goodwin, N., Nelson, J. A., Harris, J. (2009), Macroeconomics in Context, M. E. Sharpe, New York, USA. • Blanchard, O. (2009), Macroeconomics (5th Edition), Pearson Prentice Hall, New Jersey, USA.

3. # Other Supplementaries # • NİNOVA(http://ninova.itu.edu.tr): Ders Kataloğu → İşletme Fakültesi → ISL244E (CRN: 22113) Makroekonomi (Koordinatör: Derya Karakaş) → Dersin Kaynakları (Syllabus, Slaytlar, Ders Notları vs.) • AKADEMİ (http://www.akademi.itu.edu.tr/sdegirmenci): - Uygulama dersleri (saat değişikliği, iptal vs.), - Ödevler, - Sınavlar ve sınav sonuçları, ile ilgili bütün duyurular. • sdegirmenci@itu.edu.tr, sdegirmenci@gmail.com, sdegirmenci@facebook.com, @sdegirmenci (twitter) • Tel.: 0 212 293 13 00 (Internal: 2672) • Room No.: B203 (İşl. Müh. BölümSek. Çapraz Karşısında) • Office Hours: Monday, Tuesday and Thursday (08:30-17:30)

4. # Today # • GNH (2009), Macroeconomics in Context: - Chapter 1:EconomicActivity in Context: • Review Questions(RQ): 2-3-5-6-7-9-10 (Page: 20) • Exercises(E): 1-2-3-4-5 (Page: 20-21) • Blanchard (2009), Macroeconomics: - Chapter 1: A Tour of theWorld: • Quick Check (QC): 2-3 (Page: 38)

5. GNH-Chapter 1: RQ-2(Page: 20) • How does macroeconomics differ from microeconomics? • ANSWER: (Textbook: p.3-4-5) Macroeconomics is the study of how economic activity at all levels create a national (and global) economic environment, while microeconomics deals with the economic activities and interactions of individuals, households, businesses, and other groups at the sub-national level.

6. GNH-Chapter 1: RQ-3 (Page: 20) • What is the difference between positive and normative questions? • ANSWER: (Textbook: p.6) Positive questions concern issues of fact (how things are), while normative questions deal with goals and values (how things should be).

7. GNH-Chapter 1: RQ-5 (Page: 20) • What is economic development?What factors are important in ensuring that economic growth benefits a country’s population as whole? • ANSWER: (Textbook: p.6-7-8-9) Economic development is the process of moving from a situation of poverty anddeprivation to a situation of increased production and plenty, through investmentsand changes in the organization of work. To benefit the population of a countryas a whole, economic development must keep pace with population growth,produce goods that increase well-being (the “what?” question), use methods ofproduction that increase well-being (the “how?” question), and the gains must bedistributed across the population (the “for whom” question).

8. GNH-Chapter 1: RQ-6 (Page: 20) • Why are macroeconomic fluctuations a cause for concern? • ANSWER: (Textbook: p.10) Economic fluctuations make it hard for people to plan for the future. High unemployment is associated with many signs of social stress, including suicide, domestic violence, stress-related illnesses and crime.

9. GNH-Chapter 1: RQ-7 (Page: 20) • What global developments have caused financial, social, and ecological sustainabilityto become increasingly prominent as macroeconomic concerns? • ANSWER: (Textbook: p.11-12-13) Financial sustainability has become a concern in poor countries due to the “debt crisis,” and in rich countries due to fears about future tax burdens.(Textbook: p.12) Social sustainability has become a concern, as people have come to question whether traditional “development” will ever solve the problem of global disparities in living standards, and whether “more-is-better” values are good for people. (Textbook: p.12-13) Environmental sustainability has become a concern as scientists have pointed out the effects of economic activities on global climate and other natural systems. (Textbook: p.13)

10. GNH-Chapter 1: RQ-9 (Page: 20) • What historical developments and concerns motivated—and what beliefs characterized—the classical economists? The work of John Maynard Keynes? The school of Keynesian economics? The work of the monetarists? The synthesis of Keynesian and classical thought? • ANSWER:(Textbook: p.14-15-16-17-18) The classical economists were motivated by observing the Industrial Revolution, and believed that the division of labor, specialization, capital accumulation and self-interested actions in markets led to the creation of wealth. They also assumed that monetary issues affected only prices. John Maynard Keynes was motivated by observing the Great Depression, and believed that the key to getting out of slumps was to raise aggregate demand through government control of investment. Keynesian economists followed J.M. Keynes, but believed that fiscal policy (not government control of investment) should be used to get an economy out of a slump.The monetarists were also motivated by observing the Great Depression, but believed that it was caused by bad government monetary policies. The synthesizers of the classical and Keynesian schools were motivated by observing the combination of rising unemployment and rising inflation that occurred in the early 1970s. They believed that Keynesian theory explained the short run (the course of the economy before markets have time to adjust) while classical theory explained the long run (after the economy has had time to adjust).

11. GNH-Chapter 1: RQ-10 (Page: 20) • What historical development took place in 1973-74, and what ongoingmacroeconomic issues did it bring into focus? • ANSWER: (Textbook: p.18) In 1973-74 the economy experienced an oil crisis created when OPEC countries cut production and raised prices. This brought economists’ attention to international linkages and to the supply side of the economy.

12. GNH-Chapter 1: E-1 (Page: 20) – Self Study • This class will be more meaningful to you, the more you pay attention to what is going on in the macroeconomy around you. Find an article in a newspaper or newsmagazine (hardcopy or on-line) that deals with a macroeconomic topic. Make a list of terms, concepts, people, organizations, or historical events mentioned in the article that are also mentioned in this chapter. • ANSWER: Students should be able to easily come up with an article that mentions GDP, the Federal Reserve, unemployment, etc. You should also accept articles that look at sustainability, such as articles on international debt issues, education spending, or environmental damage.

13. GNH-Chapter 1: E-2 (Page: 20) • Classify each of the following as to whether it is an example of a positive question or a normative question. a. “What is the level of U.S. foreign debt?” b. “How low should the unemployment rate be?” c. “What policies can lower the unemployment rate?” d. “What kinds of production should be counted in measuring gross domestic product?” e. “Is it better to have low unemployment or low inflation?” • ANSWER:(Textbook: p.6) a. positive b. normative c. positive d. normative e. normative

14. GNH-Chapter 1: E-3 (Page: 20-21) • State whether the following statements are true or false. If false, also write a corrected statement. a. Macroeconomics is about the activities of governmental agencies. b. Economic growth always leads to living standards growth. c. The three areas to consider in thinking about sustainability are financial, monetary, and ecological. d. About 20% of the world’s population lives in absolute poverty. e. Poor countries were offered many foreign loans for economic development over the last several decades; now all of them are paying back the loans easily. • ANSWER: Examples of correct answers: a. False. Macroeconomics is about the national or global economic environment created by all actors, including but not limited to government agencies. (Textbook: p.4) b. False. Economic growth may not lead to living standards growth if the questions of “what, how and for whom” are not well-addressed. (Textbook: p.9) c. False.“….financial, social, and ecological” (Textbook: p.11-12-13) d. True. (Textbook: p.7) e. False“…: now many of them face a debt crisis and pay more in interest than they receive in grants and loans.” (Textbook: p.12)

15. GNH-Chapter 1: E-4 (Page: 21) • State whether the following statements are true or false. If false, also write a corrected statement. a. Fiscal policy refers to government influences on credit and interest rates. b. Specialization and the division of labor are characteristics of industrial production. c. Classical economists believe that the Great Depression was caused by aggregate demand being too low. d. During “bank runs” and stock market crashes, people lose confidence in the financial system and tend to cut back on their spending. e. Keynesian economists believe that an economy that experiences a high rate of unemployment will quickly self-correct. • ANSWER: Examples of correct answers: a. False. “Monetary policy…” (Textbook: p.16) b. True.(Textbook: p.14) c. False. “Keynesian economists…” (Textbook: p.15-16) d. True. (Textbook: p.15) e. False. “Classical economists…” or “Keynesian economists believe that an economy that experiences a high rate of unemployment requires fiscal policy (and perhaps monetary policy) actions to recover.” (Textbook: p.15-16-17)

16. GNH-Chapter 1: E-5 (Page: 21) ANSWER: a-5; (Textbook: p.15-16) b-8; (Textbook: p.14-15) c-6; (Textbook: p.16-17) d-1; (Textbook: p.16) e-9; (Textbook: p.6-7) f-7; (Textbook: p.10-11) g-11; (Textbook: p.16-17) h-2; (Textbook: p.4) i-3; (Textbook: p.15) j-10; (Textbook: p.4) k-4.(Textbook: p.7)

17. B-Chapter 1: QC-2 (Page: 38) • Macroeconomics Policy in Europe Beware of simplistic answers to complicated macroeconomic questions. Consider each of the following statements and comment on whether there is another side to the story. a. There is a simple solution to the problem of high European unemployment: Reduce labor market rigidities. b. What can be wrong about joining forces and adopting a common currency? The euro is obviously good for Europe. • ANSWER: a. More flexible labor market institutions may lead to lower unemployment, but there are questions about how precisely torestructure these institutions. The United Kingdom has restructured its labor market institutions to resemble more closely U.S. institutions andnow has a lower unemployment rate than before the restructuring. Onthe other hand, Denmark and the Netherlands have relatively lowunemployment rates while maintaining relatively generous socialinsurance programs for workers. In addition, some economists argue that tight monetary policy has at least something to do with the high unemployment rates in Europe. b. Although the Euro will remove obstacles to free trade between European countries, each country will be forced to give up its own monetary policy.

18. B-Chapter 1: QC-3 (Page: 38) • Productivitygrowth in the United StatesandChina Productivity growth is at the heart of recent economic developments in the United States and China. a. How has China achieved high rates of productivity growth in recent decades? b. How has the United States achieved high rates of productivity growth in the past decade? (You can base your answer on the views of optimists about U.S. productivity growth.) c. Why do you think your answers to parts (a) and (b) are different? To what degree do you think China’s methods of achieving productivity growth are relevant to the United States? d. Do you think China’s experience provides a model for developing countries to follow?

19. B-Chapter 1: QC-3 (Page: 38) • ANSWER: a.The Chinese government has encouraged foreign firms to produce in China. Since foreign firms are typically more productive than Chinese firms, the presence of foreign firms has lead to an increase in Chinese productivity. The Chinese government has also encouraged joint ventures between foreign and Chinese firms. These joint ventures allow Chinese firms to learn from more productive foreign firms. b.The recent increase in U.S. productivity growth has been a result of the development and widespread use of information technologies. c.The United States is a technological leader. Much of U.S. productivity growth is related to the development of new technologies. China is involved in technological catch-up. Much of Chinese productivity growth is related to adopting existing technologies developed abroad.  d.It’s not clear to what extent China provides a model for other developing countries. High investment seems a good strategy for countries with little capital, and encouraging foreign firms to produce (and participate in joint ventures) at home seems a good strategy for countries trying to improve productivity. On the other hand, the degree to which China’s centralized politicalcontrol has been important in managing the pace of the transition and in protecting property rights of foreign firms remains open to question.

20. tobe continued…