• US dipping into pensions as it hits debt ceiling (Reuters)
• Debt Ceiling D-Day (ABC News)
• Feds Reach Debt Ceiling (Wall Street Journal)

Today in class, your goal is to see if YOU can lower the US budget to $12.8 trillion (60% of GDP).  We will use the CRFB budget simulator.

1) The current account balance of the United States

2) The primary countries that we import from.

• #1: A government budget deficit (or surplus) is for a specific unit of time…say a year.  If (within that time period) the govt brings in less tax revenue that it spends in expenses, then, for that year, the government has a budget deficit.  So, you could say that in the year 1902 there was a budget deficit and perhaps in the year 1903 a budget surplus.  Government (or public) debt refers to the accumulation of debt over all time.  So, in all those years when there is a budget deficit, the government borrows (just like an individual) to pay for the extra.  Government debt is the overall amount that “we haven’t paid back on our credit card.”
• #3a: If a country is in a recessionary (or deflationary) gap, it implies that we need to get things going in the economy–expand things–expansionary policy.  Fiscal expansionary policy tries to manipulate (increase) spending, thus shifting AD to the right.  The diagrams on page 251 (9.1 a and b) show how the Neoclassicists and Keynesians would diagram this.
• #3b: On the other hand, to solve an inflationary gap, we need to cool things down–contract things–contractionary policy.  Fiscal contractionary policy tries to decrease spending, thus shifting AD to the left.  See diagram 9.2 a and b on page 252.
• #4a: a lowering of income taxes implies that people will have more disposable income to spend.  AD should shift outwards (to the right).  See Figure 9.1.
• #4b: decreased govt spending on defense means there is less overall spending in the economy, leading to a left-ward shift in AD. See Figure 9.2.
• #4c: govt increases on business profits make it more difficult to do business.  Businesses are likely to purchase fewer inputs into their product (or service), shifting AD to the left. See Figure 9.2.
• #4d: govt increases on infrastructure spending are themselves additional spending and thus a right-ward shift in AD.  See Figure 9.1

TYU 9.2

• #1a: As the size of the money supply shrinks, money becomes more and more valuable (and “hard to get”).  So, the “cost of money”–interest–goes up.  Likewise, as the size of the money supply grows, money becomes less valuable, “easier to get” and thus the interest rate falls.  See Figure 9.3 on page 254.
• #1b: Central Bank of each country
• #2a: Goals of monetary policy are: control the supply of money, determine the rate of interest, oversee the banking system, and carry out monetary policy. (pg 252 of Tragakes)
• #2b: Expansionary Policy: goal is to increase (move to the right) AD / drop interest rates to make money “easier to get” so people spend more (increasing AD)  /// Contractionary Policy: goal is to decrease (move to the left) AD / increase interest rates to make money “harder to get” so people spend less (decreasing AD)
• #2c: See 2b
• #2d: C(onsumer) and I(nvestment)
• #2e: Interest rate moves up or down to make the “cost of money” correspondingly higher or lower.  This change in the “cost of money” is what manipulates peoples spending, and thus shifts AD.
• #4a: Fall in rate of interest / Expansionary Policy / Fig 9.1 on pg 251
• #4b: Increase in rate of interest / Contractionary Policy / Fig 9.2 on pg 252

TYU 9.4 All
TYU 9.5 All
TYU 9.6 #1

• TYU 9.1 #1, #3, #4
• TYU 9.2 #1, #2, #4

Due Fri:

• TYU 9.3 #4
• TYU 9.4 All
• TYU 9.5 All
• TYU 9.6 #1

• 1a Identify the components of aggregate demand and briefly explain two factors that might determine each of these components (10 marks)
• 1b Evaluate the likely impact on an economy of a substantial rise in the level of interest rates. (10 marks)

Question Possibility #2: (15 total marks)

• Discuss some factors that cause GDP figures to (a) understate a society’s true welfare; (b) overstate a society’s welfare; (c) understate or overstate a society’s welfare. (15 marks)

Question Possibility #3: (10 marks)

• Using the production possibilities model and diagrams, evaluate the following statements: (a) it is very difficult, if at all possible, for economic development to occur without economic growth. (b) If economic development is to be maintained over a long period of time, economic growth is essential.

Question Possibility #4: (10 marks)

Using diagrams and the neoclassical AD-AS model, explain the impact each of the following would have on Country A’s short-run equilibrium price level, real GDP, and level of unemployment:

• (a) consumer and business pessimism about the future of the economy
• (b) a war that restricts supplies of key inputs
• (c) a drop in interest rates
• (d) an increase in wages due to trade union activities (with the price level constant)
• (e) a fall in the price of oil (a major resource)

Question Possibility #5: (15 marks)

• Using diagrams and the concepts of inflationary and recessionary (deflationary) gaps, show if and how it is possible for the equilibrium level of real GDP to differ from the full employment level of real GDP: (a) in the neoclassical short run; (b) in the long run; (c) in the Keynesian version of the AD-AS model.

#3: Even during a period of time where there is ’full employment level of output’, unemployment is not actually at zero.  Some people might be moving between jobs, or in school, or not working because they have a chronic illness.  This baseline, reasonable (honestly, unavoidable) level of unemployment is called the “natural rate of unemployment.”  If a country only has the ”natural rate of unemployment,” it is said to have reached a ‘full employment level of output.’  Similarly, if a country has reached their ‘full employment level of output’, then their real GDP equals their potential GDP.

#4:

• (a) horizontal potential GDP line: The slope of the potential output curve is related to the rate of economic growth (in the long term).  So, in the case of a potential GDP curve being horizontal (or flat), one could guess that they are seeing little to no growth of their economy.  We do not know (simply by knowing the slope of the curve) whether there are large or small fluctuations in price (inflation / deflation) and employment.
• (b) downward-sloping potential GDP line: A downward-sloping curve indicates that negative economic growth is occurring.  The negative slope also suggests that periods of contraction (when unemployment increases) are longer (time-wise) than period of expansion (when unemployment falls).

TYU 8.2

#1 (a): Aggregate demand is “the total quantity of goods and services that all buyers in an economy want to buy at different possible price levels, ceteris paribus.”  Keep in mind that the total quantity of goods is shown by GDP (as opposed to “quantity”, as we did in Micro).

#1 (b): Aggregate demand curve shows the relationship between the total quantity of goods and services people want to buy (real GDP demanded) and the economy’s price level, ceteris paribus. Remember that aggregate demand includes:

• demand of consumers (C)
• demand of firms (I)
• demand of government (G)
• demand of foreigners for exports – imports (X-M for net exports)

#1 (c): Movements along the curve are caused by changes in the overall price level.

#1 (d): The four components of spending are the bullet points in #1 (b).

———

#2 (a): Consumers become optimistic about future conditions in the economy (the level of employment, the level of income, expected economic growth, etc.)

Which component of aggregate expenditure is involved?

• Consumer spending

#2 (b): The government decides to increase taxes on firms’ profits

Which component of aggregate expenditure is involved?

• Investment spending

#2 (c): Firms become fearful that a recession is about to begin.

Which component of aggregate expenditure is involved?

• Investment spending

#2 (d): The government decides to increase its spending on health care services

Which component of aggregate expenditure is involved?

• Government spending

#2 (e) There is a decline in the real estate market (average house prices fall).

Which component of aggregate expenditure is involved?

• Investment spending

#2 (f) The central bank (a government organization) decides to increase interest rates

Which component of aggregate expenditure is involved?

• investment spending

#2 (g) Real incomes in countries that purchase a large share of country A’s exports fall; examine the impact on aggregate demand in country A.

• Answers for Part I (questions and definitions) / this will probably be ONE piece of paper
• Tables / Graphs / Writing for Part II / this will be FIVE pieces of paper (or perhaps some back and front action)
  • Page 1: Country A Table and Graph
  • Page 2: Country B Table and Graph
  • Page 3: Country C Table and Graph
  • Page 4: Country D Table and Graph
  • Page 5: Written response (fairly short)

Today you are going to use the World Bank data website to glean data and investigate the following guiding questions:

Which criteria are used to divide countries into various economic classifications? (like “developed” vs. “developing”)

To what extent are these classifications accurate indicators of the “health” of a particular country?

All of today’s work should be completed in PAIRS.  You may turn in one paper for both of you.  Make sure you put both names on your paper.

PART I: INSTRUCTIONS

• In a googledoc or word doc, answer the following questions.  Print ONE copy to turn in by the end of class.  Keep ONE copy (per person) either electronically or on paper for yourself.

1) Which criteria are used by the World Bank and the IMF to divide countries into various economic classifications? (like “developed” vs. “developing”)

• UN Classifications by geographical region and other groupings
• World Bank: How do we classify countries?
• IMF Classifications by geographical region and other groupings

2) Define the following terminology: (hint…some of the acronyms can be found on the right hand bar “organizations”)

• LEDC (Least economically developed countries) vs. MEDC (most economically developed countries)
• First world vs. Third World
• Developed vs. underdeveloped
• Industrialized vs. non-industrialized
• OECD
• European Union
• G8
• ASEAN-5
• MENA

3) To what extent are these groupings subjective or objective?

4) What are your thoughts on the terminology of “developing” vs. “developed”?  Useful or offensive terms?

PART II: INSTRUCTIONS

1) First, I want you to familiarize with the World Bank data website.  Look at this example.  If you scroll over the small magnifying glasses (top right of each box), you will see the word “source” pop up.  Click it.  Read a few descriptions to familiarize yourself with the terminology and setup.

2) Use the main site (World Bank data website) to choose:

• ONE low income country
• ONE lower middle income country
• ONE upper middle income country
• ONE high income (OECD or not, doesn’t matter)

Hint: click on, for example, “low income”.  This will take you to a page which gives you a summary of all the countries in that category.  Scroll down and you will see a list of all countries included in that category.

3) Next, use the Indicator tab to choose “GDP (current US$)”.  Keep in mind that this is NOMINAL GDP.

4) Instead of looking at the graph, choose “Table”

5) Use the table to collect data for your FOUR countries.  Pull data in 5 year increments between the years 1980-2010.  Create a table in googledocs or excel to show your data.

6) Repeat the process for the Indicator of Inflation, GDP deflator (annual %).  Make sure you pull data for the same years.

7) You will now need to calculate Real GDP using the GDP Deflator information.  Here is the equation:

GDP Deflator = Nominal GDP/ Real GDP

To read more about how to use the GDP Deflator to convert Nominal GDP to Real GDP, click here.

8 ) Create now a third chart which lists Real GDP.

9) Your final product for the day is FIVE pieces of paper.  On each of the first four you will have a table showing the data for each country and a graph of the data.  You may use googledocs or excel to create them, or you may NEATLY hand-draw.  On the fifth you will have a written response.

• Each table should include Real GDP, Nominal GDP and the GDP deflator percentage.
• Each graph should show Real GDP and Nominal GDP.  (Hint: time on the x axis and $ on the y axis).
• On the fifth page, write your thoughts on the gap between Real and Nominal.  How do the four countries you chose compare?  Is there a pattern that relates to which economic classification each country is in?  (Remember, they have been grouped based on their GDP per capita).
• Finally, I want to hear your thoughts on our original question:

To what extent are these classifications accurate indicators of the “health” of a particular country?

• If you have time, you can look at some of the other indicators we’ve talked about in class (like maternal mortality or number of cell phones) and see what connections you can find to answer our guiding question.  Otherwise, use the general information you have from class discussions to guide your writing here.