For all Economics Enthusiats

[WinePusher]

Part 1: National Income and GDP

Question 1) What determines the amount of output an economy produces?

The amount of output that an economy produces is determined by the production function along with the amount of inputs that are available. Economists refer to these inputs as the factors of production which include land, labor, capital and entrepreneurship, the most important being labor and capital. The production function states that output is a function of these inputs. It can be written mathematically as Y=F(L,K) where Y represents total output, L represents labor and K represents capital.

Question 2) Explain how a firm decides how much of each factor of production to demand.

In order to answer this question we must first understand the following concepts.

The marginal product of labor (MPL) refers to the extra amount of output the firm gets from hiring one extra unit of labor. Similarly, the marginal product of capital (MPK) is the amount of extra output the firm gets from employing one extra unit of capital. Diminishing returns (also called diminish marginal productivity) tells us that if one input is increased while all other inputs are held constant then the productivity of that input will decrease as more of it is used. In other words the marginal product of labor will decrease as the amount of labor increases and likewise the marginal product of capital will decrease as the amount of capital increases.

Thus, the firm will demand each factor input until the marginal productivity of the factor equals its factor price. If the marginal product falls below the factor price then the firm will no longer employ the factor input.

Question 3) What is constant returns to scale?

Returns to scale provide details about a production function. A production function is said to have constant returns to scale if an increase of an equal percentage in all inputs results in an equal percentage increase in output. Constant returns to scale simply means that inputs and output change by an equal amount.

Question 4) Define GDP and explain the three approaches to measuring the national income accounts.

GDP is defined as the market value of all final goods and services produced in an economy during a specified period of time. The components of GDP include consumption, investment, government expenditures and net exports. This can be mathematically written as Y=C+I+G+NX.

Aggregate economic activity, otherwise known as the national income accounts, can be computed by three equivalent methods. The first method is the product method. This method is based upon the concept of value added, that is the value of output minus the value of the inputs purchased from other producers. The product approach computes economic activity by summing up the value added of all producers in the economy. The next method is the income method, and it can be calculated by adding up all the income received by producers of output, including the wages to labor and the profits to entrepreneurs. Lastly, the expenditures method measures economic activity by adding up total spending in the economy. These three approach are ultimately equivalent because total production (the product method) must equal total income (the income method) must equal total spending (the expenditures method). This is called the fundamental identity of national income accounting.

Question 5) What determines consumption and investment?

Consumption is determined by disposable income. This can be written mathematically as C=C(Y-T) where C represents consumption, Y represents income and T represents taxes. Y-T represents disposable income or the income that remains after taxes. Another key determinant is the marginal propensity to consume (MPC) which is always between 0 and 1. If the MPC were .7 then that means that consumers spend 70% of each additional dollar they earn. Investment is simply a function of interest rates.

Question 6) How does GNP differ from GDP?

GNP (Gross National Product) is the market value of all final goods and services produced by domestic factors of production. When domestic capital and labor are used abroad they earn income and produce output, and this output and income is included in the GNP but not the GDP because it doesn't represent production taking place abroad. So, basically GDP takes into account economic activity that takes place in a particular region while GNP takes into account economic activity from domestic inputs that takes place around the globe. The actual difference between GNP and GDP is miniscule.

Question 7) Explain how equilibrium is achieved in the goods market.

Simply put, the goods market is in equilibrium when savings is equal to investment. Recall the equation for national income: Y=C+I+G+NX. We can manipulate this using simple algebra to shed light on this concept. First, we will remove net exports from the equation and assume a closed economy that doesn't engage in international trade. Such an economy is said to be in autarky.

Y=C+I+G (we have removed net exports NX)
Y-C-G=I (subtract C and G from both sides)
S=I (Y-C-G is equal to national savings)

Therefore, the goods market is in equilibrium when savings equals investment. Thus far our analysis has been very simplistic. In reality most economies are open economies that engage in international trade and the economy as a whole is comprised of both the goods market and the money market/asset market. We will expand our analysis in later parts.

Part 2: Money and Inflation

Question 1) Define money and list the three functions of money.

Money can be simply defined as anything that is widely used and accepted as payment. In modern economies money includes the currency in circulation along with demand deposits held in banks. Money functions as a medium of exchange, or a device used for making transactions. This can be contrasted with a pure barter economy where no medium of exchange exists, and as a result the amount of transactions that take place in a barter economy are substantially smaller than the amount of transactions that take place in economies that have mediums of exchange. Secondly, money acts as a unit of account. For example, prices in the United States are denominated in dollars. Money essentially acts as a type of measurement or metric system that prices all goods and services within and economy. Thirdly, money is a store of value in the same way other assets such as stocks and bonds preserve wealth.

Question 2) List and explain the two types of inflation.

The first type of inflation is known as demand pull inflation, and this is the most prevalent type of inflation. Demand pull inflation occurs when aggregate demand grows at a faster pace than aggregate supply does, and as a result prices rise. Demand is essentially pulling prices upward. The second type of inflation is known as cost push inflation and it occurs when the price of inputs increases. Recall that firms require inputs/factors of production in order to generate output. Like anything else, firms must make payments to these factors of production. Firms must pay wages to labor, interest to capital, rent to land and profits to entrepreneurs along with payments to purchase raw materials. If the price of any one of these goes up then firms will react by raising prices in order to compensate the differential. So, the increase in the costs of production pushes prices upward.

Question 3) Write the quantity equation/equation of exchange and explain it.

The quantity equation, also referred to as the equation of exchange, is M x V=P x T where M=Money, V=Velocity, P=Price and T=Transactions. The equation shows the relationship between these 4 variables. The right side tells us about transactions and the left side tells us about the money used to make those transactions. In the context of monetary economics, velocity measures the rate at which money is circulated throughout an economy and it can be computed by solving the exchange equation for V, where velocity is equal to price times transactions divided by money or V=PT/M.

In macroeconomics the transaction portion of the exchange equation can be substituted for Y which represents total output. Therefore, P x Y gives us GDP and we can see velocity as equaling GDP divided by money. Intuitively speaking, this means that the smaller the money supply is the quicker that money will be turned over to facilitate transactions. As a result a small supply of money causes the velocity of money to increase.

Question 4) What does the assumption of constant velocity imply?

If we assume that velocity is constant then the equation of exchange, which is an equation-not a theory, essentially becomes the foundation for the quantity theory of money. The quantity theory of money essentially states that the general price level in an economy is directly related with the quantity/supply of money. This prediction only holds true if velocity is fixed.

Question 5) Explain the money demand function and the three motives for holding money.

The demand for money is a concept that originates with Keynes, who coined the term 'liquidity preference' which essentially means the preference people have for liquidity (money). A simple money demand function can be written as Md=F(P,I,Y) where Md=the demand for money, P=Price, I=Interest Rates and Y=Real Income. What this function tells us is that the amount of money people demand is a function of the interest rate, their real income and the price level. From question 3 we already know that the demand for money is negatively related with interest rates. When interest rates increase then peoples demand for money decreases and velocity rises.

Additionally, Keynes also intuitively theorized that there are 3 motives for holding money. First being the transactions motive which is self explanatory. People hold onto a certain amount of cash in order to buy stuff and make transactions. Secondly, Keynes posited a precautionary motive for holding money which is just based upon expected future transaction. Simply put, people hold money in order to safeguard themselves against things that might happen in the future. Finally, Keynes also claimed that there was a speculative motive for holding money where we saw money as a type of asset that could earn a rate of return. In order to understand this speculative motive we must first understand the relationship between interest rates and bond. They are inversely related, meaning that if bond price fall interest rates go up and vice versa. At higher interest rates, the rates of return on bonds will be higher as well causing people to hold bonds instead of money. From this speculative motive we can conclude that money and interest rates are also inversely related.

Question 6) Explain how equilibrium is achieved in the assets/money market.

Equilibrium in the money market occurs when the quantity supplied of money equals the quantity demanded for money. The interest rate is once again the variable that determines where equilibrium occurs at. In order to fully understand equilibrium in both the goods and assets markets we must consider the ISLM model which will be discussed later.

Question 7) Define 'monetary base' and 'money multiplier' and explain how money can be created in a fractional reserve banking system.

The monetary base can be seen as all the liabilities of a central bank, which include currency in circulation and bank reserves. This is different from the money supply which is defined as currency + demand deposits. The money multiplier can be written as 1 over the reserve ratio or 1/rr. The money multiplier measures the amount of money that can be created in a fractional reserve banking system.

Now, let us assume a full reserve banking system for a moment. In such a world, when you deposit your money in a bank the bank hangs onto all of it and therefore it can make no loans. Therefore, money creation in the context of a full reserve banking system is impossible. However, in a fractional reserve banking system the banks only needs to hang onto a fraction of your deposit and can loan the rest of it out. The amount of money the bank loans out is equal to the amount of new money that is created. By making loans banks can create money.

Question 8) What are the three tools of monetary policy that the Federal Reserve can use?

The most common way the Federal Reserve controls the money supply is through open market operations whereby the Fed purchases or sells government bonds from the public. If the Fed wishes to increase the money supply then it will purchase bonds, and if the Fed wishes to decrease the money supply it will sell bonds. The Federal Reserve may also change the required reserve ratio, however it rarely does so as this tool can greatly disrupt and destabilize the banking system. If the Fed were to increase the required reserve ratio then banks would be forced to hold onto a greater percentage of deposits, this would subsequently reduce the number of loans being made which would shrink the money supply. If the reserve ratio were decreased then more loans would be made and the money supply would increase. Finally, the Fed exerts minor influence over the money supply through the discount rate. This is the rate at which banks borrow funds directly from the Federal Reserve. The lower the discount rate the more banks will borrow from the Fed's discount window which increases the money supply.

Part 3: Open Economies and International Economics

Question 1) What are the net capital outflow and the balance of trade? How are they related?

Recall that national income is represented by Y=C+I+G+NX. We will rewrite this equation using simply algebra in order to shed light on what the net capital outflow is.

Y=C+I+G+NX (this is the given equation)
Y-C-G=I+NX (subtract C and G from both sides)
S=I+NX (replace Y-C-G with S because Y-C-G is national savings)
S-I=NX (subtract I from both sides)

The left side of the equation is the net capital outflow and the right side is the balance of trade. The net capital outflow measures the flow of funds being invested abroad by a country, a positive net capital outflow means that investment in foreign countries more than foreigners are investing in the country. If the net capital outflow is negative then investment abroad is less than what foreigners are investing in the country. The balance of trade refers to the relationship between imports and exports. If exports exceed imports then we have a trade surplus, if imports exceed exports then we have a trade deficit.

Question 2) What is the nominal exchange rate and the real exchange rate?

The nominal exchange rate is simply the rate at which currencies can be exchanged for one another. The real exchange rate is essentially what the terms of trade is. The terms of trade, or the real exchange rate, measures the price of domestic goods in terms of foreign goods.

Question 3) What is the relationship between the value of a countries currency and the countries balance of trade.

In order to answer this question we must first understand what appreciation and depreciation means. Appreciation refers to an increase in the value of a currency and depreciation refers to the loss of value in a currency. Now, if we hold everything else constant, the depreciation of a currency will cause exports to increase and, likewise, the appreciation of a currency will cause imports to rise. In other words, if we have a strong dollar then we're likely to run a trade deficit but if we have a weak dollar then we're likely to run a trade surplus. The reasoning behind this is very simple. If the dollar loses value it becomes cheaper in the foreign exchange market and, as a result, the demand for dollars (and domestic goods) on the part of foreigners increases, ie exports increase. If the dollar gains value it becomes more expensive in the foreign exchange market and the demand for dollars and domestic goods on the part of foreigners decreases, ie imports increase.

Question 4) Provide a detailed explanation of the balance of payments accounts and its components.

The balance of payments accounts keep record of a country's international transactions. Any transaction that involves a flow of money into the country is a credit item while any transaction that involves a flow of money out of the country is a debit item. The balance of payments accounts can be further divided into the current account and the capital account. The current account measures the country's trade in regards to goods that are currently produced while the capital account records transfers of money and assets between countries.

Part 4: Economic Growth: The Solow Model

Some preliminary concepts: The capital stock is the total amount of capital goods that exist in an economy at a given moment in time. Capital accumulation simply refers to an increasing capital stock and productivity and technological progress are two terms that can essentially be used interchangeably because technological progress results in higher productivity.

Question 1) Briefly explain the general idea behind the Solow Growth Model.

The Solow Growth Model relates three economic variables: savings, population growth and technological progress and shows how these three variables affect an economy's real output over time Specifically, the Solow model shows that in the long run, an economy's rate of savings will determine the size of it's capital stock, which in turn will determine the overall level of production. In order to fully grasp the Solow Growth Model we must first understand the production function that lies at the heart of it.

1. Y=F(K,L) (this is the given production function)
2. zY=F(zK,zL) (the Model assumes constant returns to scale, so if L and K are multiplied by some number z then Y must also be multiplied by that same number z)
3. Y/L=F(K/L,1) (our goal is to break down the production function into per worker terms, so we set z=1/L and simplify)
4. y=f(k) (this is the per worker production function that we end up with. the function shows that output per worker is a function of capital per worker)

Question 2) In the Solow Model, how does the savings rate affect the steady state level of income? How does it affect the steady state level of growth?

We will first begin by defining what a 'steady state' level is. A steady state is a situation where the economy's output per worker, consumption per worker and capital stock per worker are constant, meaning that none of these variables change overtime. As we have already pointed out, the savings rate is the key determinant of the steady state capital stock. Thus, if the savings rate is high the economy will have a large capital stock and a high level of output, but if the savings rate is low the economy will have only a small capital stock and a low level of output.

Now, in order to answer the question we will turn our attention to two concepts called the level effect and the growth effect. Higher savings will lead to high economic growth in the Solow model, but only temporarily. The economy will only grow until a new steady state is reached, and once the economy gets there it will stay there regardless of what the savings rate it. Once we are actually in the steady state, we can look at these two effects. The level effect states that in the steady state only the level of income per person, and not the growth rate, is influenced by the savings rate. Raising savings in a steady state economy will not have a growth effect, it will not cause the economy to grow, but it will have a level effect meaning that it will cause incomes to grows.

Question 3) Define and explain the Golden Rule of Capital-Labor Ratio.

Thus far, the key insights we can take away from the Solow model is that savings determines the economy's steady state level by determining the size of the capital stock. However, from a social welfare perspective a major goal is to maximize consumption, not savings or capital. This is where the Golden Rule of Capital comes into play. The Golden Rule Capital to Labor Ratio is the level of the capital-labor ratio that maximizes consumption per worker in a steady state economy.

Recall that from the national income section, output is equal to consumption plus investment or Y=C+I (we are excluding government and net exports for the time being). We can rearrange the equation to show that consumption is equal to output minus investment or C=Y-I. Our goal is to find the steady state level of consumption, which is steady state consumption is equal to steady state output minus steady state depreciation (depreciation meaning the wearing out of capital). This means that increasing the steady state level of capital has two opposing effects. First, increasing capital will increase output obviously, but the increase in capital means that more output must be used to replace depreciated capital (capital that has worn out). Having said all this, we can now derive the simple condition that illustrates the Golden Rule of Capital. At the Golden Rule level of capital, the Marginal Product of Capital (MPK) is equal to the depreciation rate of capital.

Question 4) In the Solow Model, how does population growth affect the steady state level of income and the steady state level of growth?

Here, we will expand our analysis of the Solow Model to accommodate other variables that affect growth, one of which being the population. Recall that the savings rate in and of itself cannot produce sustained economic growth, it can only produce temporary economic growth. In order to account for sustained economic growth we must incorporate population growth (which we will do here) and technological progress (which we will do later).

We will begin by analyzing how population growth affects capital accumulation per worker. Keep in mind that investment raises the capital stock and induces capital accumulation while depreciation reduces the stock. Now, in terms of population growth, the growth in the number of workers will cause capital per worker to fall. Thus, population growth will alter the Solow model in three ways. First, it explains how growth in output can be sustained overtime by showing that an increase in workers will cause capital and investment to grow at an equal rate. Second, it accounts for income and wealth discrepancies among different countries by showing that countries will higher populations will have lower levels of per capita GDP. And lastly, it affects the Golden Rule of Capital that we talked about earlier. The Golden Rule states that the Marginal Product of Capital must equal the rate of depreciation. However, the rule will be altered when we introduce population growth because the Marginal Product of Capital minus the depreciation rate will equal the rate of population growth.

Question 5) In the Solow Model, what determines the steady state rate of growth of income per worker?

The steady state rate of income growth per person is determined by the exogenous rate of technological progress. We will now incorporate technological progress into the Solow Model to explain how and why this is so. Take the simple production function we've become so familiar with Y=F(K,L) and just multiply L by E to get a new, more comprehensive production function, Y=F(K,LxE). The E stands for the efficiency of labor which is defined as the way workers utilize and interact with technology. As the available technology improves so does the efficiency of labor. Therefore, as productivity rises due to advances in technological progress so does the level of income.

Question 6) Define and explain Endogenous Growth Theory.

Endogenous growth theory was developed as an attempt to explain the short comings of the Solow Growth Model (also known as the neoclasical exogenous growth model). The Solow Model tells us that long run, sustained economic growth is the consequence of savings, population growth and technological progress, the most important being technological progress. However, the model is silent when it comes to the determinants and causes of technological progress, and this is where endogenous growth theory comes into play.

The endogenous growth theory can be simply represented with the following equation, Y=AK where Y=Output, K=Capita and A is simply a constant. According to the function, each additional unit of capital increases output by A units and, as a result, the production function doesn't exhibit diminishing marginal product. The key idea to take away from this theory is that marginal productivity is constant, not diminishing and, as a result, long run growth can be sustained simply by the savings rate. This is an important difference between endogenous growth theory and the Solow Model. In the Solow model savings can induce temporary economic growth, but diminishing returns to capital will force the economy into a steady state in which growth can no longer be induced by savings, but only by technological progress. However, the endogenous theory of growth states that an economy can grow due to savings even if in a steady state because returns to capital are constant, not diminishing.

Part 5: Business Cycle Theory

Question 1) Define and explain Okun's law.

Okun's law states that there exists a negative relationship between unemployment and real GDP. Specifically, a decrease in unemployment of one percent will be associated with an increase in real GDP or about two percent.

Question 2) What are supply and demand shocks?

Supply and demand shocks are any variables that cause aggregate supply and demand to fluctuate and move away from their natural levels. We will discuss these economic shocks in more detail later on.

Question 3) What is the key difference between Classical Economists and Keynesian Economists when it comes to long run equilibrium?

When it comes to discussions of the business cycle, there are two prevailing schools of thought. The classicals and the Keynesians, both of whom have different theories of what causes the business cycle and what can be done to mitigate the effects of recessions and depressions. The key difference between the two schools is their understanding of prices. Classicals believe that prices are flexible, meaning that they can adjust rapidly to supply and demand shocks. However Keynesians assert that prices are sticky/inflexible and that prices will not adjust in the short run. Under the classical economic framework the economy will reach long run equilibrium rather quickly prices will adjust in order to set supply and demand equal to each other, thus clearing the economy of any shortages or surpluses. However, Keynesians assert that prices are sticky and that the economy will take quite some time to reach equilibrium in the long run unless the government intervenes.

Question 4) Briefly explain the Real Business Cycle Theory.

The real business cycle theory represents a strain of contemporary economic thought that takes place within the context of the classical framework. Like the classicals, the real business cycle theorists maintain that prices are fully flexible even in the short run. Additionally, the real business cycle theory also accepts the idea of the classical dichotomy which is something we've yet to explain.

The classical dichotomy states that nominal economic variables do not affect real economic variables. Nominal economic variables include things like the money supply and the price level while real economic variables include real output and employment. Real business cycle theorists assert that nominal variables and changes to nominal variables will not affect real variables. What does affect real variables and fluctuations in real variables are not nominal variables, but rather real changes in the economy such as changes in technology.

Question 5) Briefly explain the Austrian Business Cycle Theory.

The Austrian business cycle theory sees recessions and depressions as the consequence of central banking policy. According to the theory, the cause of a recession is the expansion of the money supply on the part of the central bank. What happens is that the central bank expands the money supply (for whatever reason) and this increases the availability of credit because it causes interest rates to decline. As a result of the artificially low interest rate, all spending that is particularly sensitive to interest rates and contingent upon interest rates increases. This primarily includes investment spending on the part of firms and entrepreneurs. Therefore, investment spending increases as well as production.

Since it’s cheap to take out a loan more and more business begin doing so, which increases total production in the entire economy. This is the peak of the business cycle, also known as the expansion or the boom. However, the economic boom and expansion is short lived because all the production and consumption is based entirely upon an artificial interest rate caused by the central bank increasing the money supply. The background information that one needs to understand in order to fully understand the Austrian theory is the loanable funds model. The loanable funds model essentially states that loans are supplied by savers and demanded by borrowers. The mechanism that facilitates the exchange between savers and borrowers is the interest rate. In a pure market economy absent a central bank, the interest rate would be determined by the supply of savings. If people were saving a lot, the interest rate would decline and borrowing would increase. If people weren’t saving that much, the interest rate would increase and borrowing would decline. So, in this sense the interest rate is a price that conveys information to entrepreneurs.

It tells entrepreneurs if consumers are saving and whether or not they should increase investment spending in order to ramp up production. Banks take the savings of consumers, and channel them into loans that businesses then use to increase their productive capacity. According to the theory, however, the central bank comes in and skews the information the price (interest rate) conveys. By arbitrarily increasing the money supply the interest rate is not reflective of real savings in the economy, it is reflective of the central bank’s policy.

Therefore all the economic activity occurring as a result of the low interest rate is not real, it is instead artificial. The economy is growing, however it is growing within a bubble that will eventually pop. And when the bubble does pop, the economy falls from its peak and hits a troph, the boom is followed by a bust, and the expansion is followed by a contraction. This is Hayek’s Business Cycle Theory. To briefly restate it, false economic booms are caused by artificial increases in the money supply by a central bank, however the boom is unsustainable because the interest rate is reflective of the artificial money supply increases on the part of the central bank, not the real savings on the part of the consumer. Therefore, the boom must eventually end and is followed by a recession, contraction or bust.

Part 6: The ISLM Model

Some preliminary concepts: The ISLM Model is a model of aggregate demand that originated with John Maynard Keynes and was formalized by an economist known as John Hicks. The IS part of the model stands for Investment-Savings and the IS curve represents the goods market of the economy. The LM part stands for Liquidity Preference-Money Supply and represents the money/assets market of the economy. The model can be represented in graphical form in the first quadrant of the Cartesian coordinate system where real GDP is measured along the horizontal axis and interest rates are being measured along the vertical axis.

Question 1) What is the Keynesian cross and how does it explain why fiscal policy has a multiplied effect on national income.

John Maynard Keynes, in his book The General Theory, claimed that total income was determined by the spending of households, businesses and the government. Thus, the Keynesian cross is a tool used to model this insight. We will begin by differentiating between actual expenditures (the amount that households, firms and government actually spend on goods and services) and planned expenditures (the amount that households, firms and government would like to spend on goods and services). We will focus primarily on planned expenditure, which is simply equal to C+I+G. Planned expenditure is a function of higher income, which in turn leads to higher consumption, the slope of the planned expenditure curve is the MPC (the Marginal Propensity to Consume), The planned expenditure curve is sloped at a 45 degree angle, while the actual expenditure curve is sloped at a slightly steeper level and the intersection of these two curve (both are linear) gives us the Keynesian cross. Equilibrium in the Keynesian cross occurs where planned expenditure equals actual expenditure. In summary, the Keynesian cross illustrates how income is determined for given levels of planned investment and government spending.

Now, we will answer the question why does fiscal policy have a multiplied effect on national income. The reason is that higher income causes higher consumption. When an increase in government purchases raises income, it also raises consumption which will further raise income which will raise consumption and so on. As a result, an increase in government purchases or an implementation of expansionary fiscal policy will cause income to increase as a multiplied rate.

Question 2) Use the theory of liquidity preference to explain why an increase in the money supply lowers the interest rate.

In order to answer this question we must first understand that the interest rate is the opportunity cost of holding money. It is what you forgo by holding some of your assets in money, which does not generate interest, rather than interest bearing assets like bonds or bank deposits. As a result, when the interest rate increase people want to hold less money. Now, we already know that an increase in the money supply lowers the interest rate, but why is this so? Well, first we can answer this question by applying basic microeconomic supply and demand analysis which states that as supply increases the price of that supply will decrease. However, from a monetary economics perspective, the reason contains more details. If the central bank decreases the money supply then peoples real money balances decrease as well which causes interest rates to rise.

Question 3) Why does the IS curve slope downward? What relationship does the IS curve capture?

The IS curve slopes down because an increase in the interest rate will cause planned investment to fall which will in turn cause equilibrium to fall. The IS curve illustrates the relationship between interest rates and real income/GDP.

Question 4) Why does the LM curve slope upward? What relationship does the LM curve capture?

The LM curve slopes upward because the higher the level of income, the higher the demand is for real money balances and the higher the equilibrium rate of interest will be. Like the IS curve, the LM curve illustrates the relationship between interest rates and real income/GDP, except it does so from the perspective of the money market, not the goods market.

Question 5) What is the impact of a decrease in taxes on interest rates, income, consumption and investment?

In the ISLM model, changes in taxes will affect expenditure by changing the level of consumption. A decrease in taxes will put more disposable income into the pockets of consumers and this will increase planned expenditure and it will push the IS curve to the right illustrating the increase in income and the interest rate

Question 6) What is the impact of an increase in the money supply on interest rates, income, consumption and investment?

An increase in the money supply will push the LM curve downward, which illustrates an increase in real income and a decrease in the interest rate. The increase in real income will cause consumption to increase and the decrease in the interest rate will cause investment to increase.

Question 7) Define and explain the concept of monetary neutrality.

Monetary neutrality is a concept that plays a huge role in the real business cycle theory. Recall, the real business cycle theory states that nominal variables, like the money supply, have no effect on real variables such as output and employment. The concept of monetary neutrality is simply a re-statement of this idea. Money is neutral in the sense that changes in the money supply will not affect real economic variables. Economists generally agree that in the long run monetary neutrality holds true, but in the short run the concept breaks down.

Part 7: The Aggregate Demand and Supply Model

Some preliminary concepts: The Aggregate Demand and Supply Model, otherwise known as the AD-AS model, is a model of the macroeconomy that was derived from the ISLM model. The two models are essentially equivalent, however, they provide different perspectives of the economy. The ISLM model relates real output to the interest rate whereas the AD-AS model relates real output to the general price level.

Question 1) Why does the Aggregate Demand Curve slope downward?

The aggregate demand curve summarizes the results from the ISLM model by showing equilibrium income at any given price level. The AD curve slopes downward because a lower price level will increase real money balances, which lowers interest rates and stimulates investment spending thereby raising equilibrium income.

Question 2) If exports rise and imports falls what happens to the AD curve?

If net exports increase then the AD curve will shift outward. The outward shift of the AD curve due to an increase in net exports shows an increase in real income and the price level.

Question 3) If government spending increases and taxes are increased what happens to the AD curve?

Government spending has the effect of shifting the AD curve outward (increasing aggregate demand) while taxes have the effect of shifting the AD curve inward (decreasing aggregate demand). If government spending was increased at an equivalent rate by which taxes were decreased then the AD curve would essentially remain stable because the two effects would cancel each other out.

Question 4) What is the difference between the short run aggregate supply curve and the long run aggregate supply curve?

Within the AD-AS model there are two aggregate supply curves, a short run aggregate supply curve and a long run aggregate supply curve. The short run aggregate supply curve is perfectly horizontal, and it captures the idea that in the short run prices will not adjust. For example, in a one day period businesses will sell a certain amount of output at a certain price level and they probably won't change the price throughout the day. However, in the long run businesses will take supply and demand conditions into consideration and they will adjust their prices accordingly. These prices will adjust until supply matches the full employment level of output, which is another component of the AD-AS model. The full employment line is perfectly vertical, and the long run aggregate supply curve will also be perfectly vertical.

Part 8: Advanced Topics in Macroeconomics

Question 1) What were Keynes' three conjectures about the consumption function?

As we already stated from the outset, consumption is a function of disposable income. The entire concept of the consumption function originated with Keynes, as did most concepts in macroeconomics, and Keynes posited three conjectures about it. First, the marginal propensity to consume is only between zero and one. The average propensity to consume, which is just consumption over income whereas the MPC is the change in consumption over the change in income, will fall as income rises and current income is the primary determinant of consumption.

Question 2) Explain the life cycle hypothesis and the permanent income hypothesis.

The life cycle hypothesis states that income will vary over a predictable fashion over the course of a persons life. The hypothesis states that consumption depends on wealth as well as income. The permanent income hypothesis, which originated with Milton Friedman, rejects the Keynesian assumption that consumption is a function of current income. Friedman claimed that consumption was function of permanent income and transitory income, permanent income being the portion of income that people expect to persist into the future and transitory income being the part of income that people do not expect to persist. Essentially, both of these hypothesis are at odds with Keynes' claim that consumption is the result of only current income.

Question 3) Define and explain the Phillips Curve.

The Phillips curve illustrates the short run trade off between inflation and unemployment. According to the Phillips curve low levels of unemployment will be accompanied with high levels of inflation and vice versa. You will either have one or the other, but not both. The theory was set back during the 1970's due to many countries experiencing stagflation, which is simultaneous inflation and unemployment, but this case can be seen as an exception to the rule. In general the Phillips curve is accepted by most economists because it makes good intuitive sense and is supported by historical economic data.

Question 4) Define and explain the Solow Residual.

In order to answer this question we must first understand the concept of total factor productivity. Total factor productivity is simply the change in output that is not caused by any changes in factor inputs. This idea shows that output can change without any accompanying change in input, however the change cannot be directly measured. Rather, it is simply a residual and the Solow residual is what measures total factor productivity.

Question 5) Define and explain the Impossible Trinity.

The impossible trinity, which is often represented as a triangle, states that a nation cannot have 1) fixed exchange rates, 2) free capital flows and 3) an independent monetary policy all at the same time. A nation can have two but not all three. The first option that a nation can choose is to allow for free capital flows and an independent monetary policy, but not have fixed exchange rates. Instead, the exchange rate would be floating. The second option is to allow for free capital flows and fixed exchange rates but to forgo having an independent monetary policy. In this case the nation the nation has no control over the money supply. And lastly, the third option is to restrict capital flows but allow for fixed exchange rates and an independent monetary policy. In such a scenario capital cannot freely flow in and out of a country.

[WinePusher]

It's been a couple years since I took a macroeconomics class and I was pretty rusty when it came to the subject, so I spent the majority of winter break reviewing my macroeconomics texts and answering most of the questions in them.

I wanted to post the answers, and the questions, here for anyone who is taking the course and is in need of additional resources or for anyone who is curious about what economics is all about. Keep in mind that this is macroeconomics and not microeconomics, which deals with a host of different topics ranging from monopolies to indifference curves to fixed costs to elasticity etc.

The topics in the OP represent the major topics you're bound to cover in an introductory/intermediate macroeconomics course, however, I only provided intuitive and verbal explanations. I did not include the many graphs that accompany the topics and I didn't do the mathematics any justice. Particularly when it comes to the ISLM and Solow Growth Model there is much mathematics that you need in order to fully understand it.

The sections include:
Part 1) National Income and GDP
Part 2) Money and Inflation
Part 3) Open Economies and International Economics
Part 4) Economic Growth: The Solow Model
Part 5) Business Cycle Theories
Part 6) The ISLM Model
Part 7) The Aggregate Demand and Supply Model
Part 8) Advanced Topics in Macroeconomics

The 2 texts I used were Macroeconomics by Gregory Mankiw, 6th edition and Macroeconomics by Andrew Abel and Ben Bernanke 8th edition.

[JoeyKnothead]

From the OP:

I carry on, but do know I read and seek to understand what you've presented. I learned me some stuff, and I 'preciate ya for it.

I hope all is well on plates from which you sup.

What determines the amount of output an economy produces?

Was there enough biscuits to go around.

Explain how a firm decides how much of each factor of production to demand.

Obamacare!

What is constant returns to scale?

Chick on a diet.

Define GDP and explain the three approaches to measuring the national income accounts.

GDP is for them in the GOP who can't spell.

What determines consumption and investment?

How much pot I've smoked, and how much out of Doritos I am.

How does GNP differ from GDP?

By a letter.

Explain how equilibrium is achieved in the goods market.

Got just enough pot and just enough Doritos that I ain't gotta go lookin' for either at least until tomorrow.

Define money and list the three functions of money.

Money: The stuff ya use to get the stuff ya want.

1- Getting pot
2- Getting Doritos
3- Getting the old lady to run get more of either

List and explain the two types of inflation.

1- When Doritos go up 'cause they know ya got the munchies
2- When a tire goes flat

Write the quantity equation/equation of exchange and explain it.

Quantity equation divided by equation of exchange.

That's what happens when ya use that / right there.

What does the assumption of constant velocity imply?

Folks'll assume all kinds of stuff.

Explain the money demand function and the three motives for holding money.

Money demand is that you demand you some of it, 'cause you got stuff it is you wanna get.

Motive 1- Pot
Motive 2- Doritos
Motive 3- Get the old lady to do the stuff she won't normally do

Explain how equilibrium is achieved in the assets/money market.

When ya got just enough money to get just enough pot and just enough Doritos.

Define 'monetary base' and 'money multiplier' and explain how money can be created in a fractional reserve banking system.

Monetary base is how much money ya really have.

Monetary multiplier is where ya wrap all them ones in a twenty, so's folks think you got more'n ya do.

What are the three tools of monetary policy that the Federal Reserve can use?

1- Making more of it
2- Making less of it
3- Making pot legal so's it is, the money sets to flowing like molasses on a hot summer day

What are the net capital outflow and the balance of trade? How are they related?

How much money ya gotta put out...

To get a given amount of pot back.

If ya ain't got the one, it's gonna be a bit rough a-tryin' to get the other'n.

What is the nominal exchange rate and the real exchange rate?

What the cops say the pot they seized was worth.

And how much it really is.

What is the relationship between the value of a countries currency and the countries balance of trade.

As a nation allows more pot to be bought, the value of its currency increases, and how if they allow it, boy howdy, the money and the pot set to swapping hands like disease at a porn shoot.

Provide a detailed explanation of the balance of payments accounts and its components.

1- Pot, component pot
2- Doritos, component Doritos
3- That stuff the old lady gets, component don't ask, just give 'er some money and hope to heck she don't tell you all about how she saved 5 dollars by spendin' her a thousand of 'em
4- Bills, component 1 and 2, and to some extent 3, in that she'll just raise a fuss if ya don't
5- Any other money spent foolishly on stuff like food and non-alcoholic drinks

Briefly explain the general idea behind the Solow Growth Model.

Money solow can't get me the stuff it is I want.

In the Solow Model, how does the savings rate affect the steady state level of income? How does it affect the steady state level of growth?

Money solow it runs out before ya can stuff you any of it in a sock. Affects steady state level in that it's solow it's pretty steady you'll wear your socks out a-walkin' in 'em far before you will a-stuffin' 'em.

Define and explain the Golden Rule of Capital-Labor Ratio.

I'll either give you some money, or I'll do you some work, for some of that Acapulco Gold.

In the Solow Model, how does population growth affect the steady state level of income and the steady state level of growth?

If you're one of them solows, you might need to think about growing your own pot, your own Doritos, or both.

In the Solow Model, what determines the steady state rate of growth of income per worker?

Those in the sohigh who think the solows are to be exploited.

Define and explain Endogenous Growth Theory.

That's where growth is endogenous.

Define and explain Okun's law.

That's the notion where the simplest explanation might be it the best'n.

What are supply and demand shocks?

When I got me a wadful of pot money, but you ain't got none to sell.

What is the key difference between Classical Economists and Keynesian Economists when it comes to long run equilibrium?

Classical economists get powerful upset when ya call 'em Keynesian economists.

But it reaches equilibrium, 'cause them Kenesian economists kick up a fuss if ya call 'em Classicalists.

Briefly explain the Real Business Cycle Theory.

Step 1- Get money
Step 2- Run out and get some pot
Step 3- Stop by and pick up a bag of Doritos
Step 4- Get more money 'cause ya done run out

Briefly explain the Austrian Business Cycle Theory.

1- Get money
2- Buy Austrian pot
3- Stop by and puck up a bag of Doritos
4- Never buy weak dang Austrian pot again

What is the Keynesian cross and how does it explain why fiscal policy has a multiplied effect on national income.

That's crossin' pot strains, and how it makes some better of it, and how folks'll pay ya more for the having done it.

Use the theory of liquidity preference to explain why an increase in the money supply lowers the interest rate.

'Cause if I've got me a whole bunch of it, I set to lose interest in tryin' to get me some more of it.

'Cept the old lady there. 'Cause I'm here to tell tell, I'll pay to watch her get nekkid if it is, I gotta give up the pot to do it.

Why does the IS curve slope downward?

Folks is upset with 'em a-killin' folks.

What relationship does the IS curve capture?

The relationship of folks it is they've kilt, and them they've yet to.

Why does the LM curve slope upward?

'Cause L come 'fore M in the alphabet.

What relationship does the LM curve capture?

How some letters come before some others of 'em in the alphabet.

What is the impact of a decrease in taxes on interest rates, income, consumption and investment?

Folks that got trickled on now have the sensation of taste.

What is the impact of an increase in the money supply on interest rates, income, consumption and investment?

Folks can get 'em some more pot.

Define and explain the concept of monetary neutrality.

If you'll quit giving the rich tax breaks, I'll quit being upset at my own tax rates.

Why does the Aggregate Demand Curve slope downward?

Inability to purchase Viagra on an open market.

If exports rise and imports falls what happens to the AD curve?

It gets affected.

If government spending increases and taxes are increased what happens to the AD curve?

Republican heads exlode.

What is the difference between the short run aggregate supply curve and the long run aggregate supply curve?

One of 'em happens quicker'n the other'n.

What were Keynes' three conjectures about the consumption function?

Them three he did.

Explain the life cycle hypothesis and the permanent income hypothesis.

In the life cycle hypothesis, folks hypothate about a life cycle, in the the permanent income hypothesis, it's permanent income gettin' all hypothecolated.

Define and explain the Phillips Curve.

That's a dude named Phillips who has a special capacity to please the ladies.

Define and explain the Solow Residual.

Money's solow, the residual effects are I'm frettin' me gettin' me another bag.

Define and explain the Impossible Trinity.

Christianity.

'Cause they can't show it's truth.

[Furrowed Brow]

Question 5) Briefly explain the Austrian Business Cycle Theory.

The Austrian business cycle theory sees recessions and depressions as the consequence of central banking policy. According to the theory, the cause of a recession is the expansion of the money supply on the part of the central bank. What happens is that the central bank expands the money supply (for whatever reason) and this increases the availability of credit because it causes interest rates to decline.

The figure changes from country to country but roughly speaking about 95-98% of money is created by private banks as loans. They create the money out of nothing not the central bank. Recently the Bank of England admitted in a report that in the UK the banks create the loans before they have an asset to back the loan. So money really is quite literally created out of nothing.....by private banks.

The central bank influences demand for loans by setting interest rates. Demand side economics. Low interest rates the attempt to stimulate economic activity. The Austrian analysis points out that this is also a stimulus to mal investment. e.g. we all go crazy and buy houses we shouldn't. The housing market provides an example that it is not just all about interest rates. Central banks to not force or simulate banks to offer 100% mortgages or even 110% mortgages. That is a supply side problem with banks competing for custom. But then supply over heats like that and all the suppliers are discounting then that also stimulates demand. If we look at the car industry and how it has moved into finance. That is not the result of a low interest environment that is a result of banks not loaning money for cars at a rate sufficient for the car manufacturers. The kinds of potential distortions that ensue are not central banks doing. That is a supply side problem caused by suppliers desperate to maintain their markets and profit levels in turn stimulated by short termism and a focus on share price. Short termism itself stimulated by over inflated bonuses. Again not central bank doing.

Central banks have been with us for a long time so it is difficult to offer clear cut examples that can be said to be independent of the influences of central banking. But the Tulip mania of 1637 did not need the stimulus of a central bank. Whilst the presence of a central bank is sufficient for a business cycle it is not necessary.

I was at a meeting last night where a local group are trying to get a local currency scheme started based on the model of the Bristol Pound. They are also considering how to start a local municipal bank.

I find the motivation for the idea of the scheme interesting and worthy. It is an attempt to keep locally created wealth local and has arisen in response to seeing wealth extracted from the area by corporations whose head office and tax base could be across the other side of the world. I suspect an economy based on multiple local currencies would prove more stable than a central banking system. But it is essentially a step towards anti liquidity and an environment difficult for the global operators to work in as they would be forced to give up some economies of scale and deal locally, and return profits locally. In a sense it is anti free trade and a form of economic suppression putting ties on business growing too big. The result if successful would likely be a break on growth or even outright deflationary. On the other hand it is an attempt to help and provide a friendly environment to mom-n-pop businesses. The hope is that the growth that does arise is sustainable and is of social benefit and gives more back to the community and leads to a more diverse local economy. There were even considering barter systems. Very early days, this scheme may not get off the ground this time, but I think we will see more and more of these kinds of efforts. But as I tried to explain at the meeting to the very positive people there, the scheme they want to run will be tolerated whilst it remains marginal. If they are successful they will either be shut down, or legislation will be introduced to limit them, or corporations will use their economic power to undermine them.

As much as the central banks can shoulder their share of the blame I see the present ongoing economic malaise the result of globalisation, how global companies now dominate the market place, the creeping fascism that goes with the accumulation of power and wealth to a few, and having economies dominated by fewer huge corporate entities; and how they are able to move capital and jobs freely around the world playing one county off against another and exploiting the differences in labour rates, taxation etc. We are going through a phase of history in which we are witnessing a race to the lowest common denominator. A downward trend largely due to a couple of billion cheap Chinese workers entering the international market place a couple of decades ago. But if central banks have accentuated that trend the alternative is decentralisation like the Bristol Pound.

Watched an episode of Max Keiser the other day and nearly threw my shoes at the screen. Alasdair Macleod perfectly polite and civil fellah and an economic pundit who does the interviews rounds in the alternative media and Austrian, made the point that labour just needs to learn to be more flexible and accept change. He was putting the blame on labour laws and unions as far as I can tell. TOTALLY AND UTTERLY disconnected from reality. With zero hour contracts, temporary jobs exploding, the flushing out of meaningful manufacturing jobs from the economy, a reduction in wages in real terms of 10% since 2007, weak and neutered unions, folk buying their own uniforms, friends of mine having to work for free a couple of weeks the other year, other friends giving up all sorts of conditions e.g. lunch allowances (in effect a pay cut), increased Sunday working etc, ever more flexible working hours. How much more flexible do we have to get? Work 60 hrs a week for less money on call to the boss and maybe pay for heating the office? To his credit Max Keiser pulled him up on the point.

I guess that is my beef with Austrian economics. It makes a couple of good points but many of its proponents I listen to are disconnected from reality and seem to be stuck in an ideology that misunderstands the nature of power and the effect on the working and poorer classes far more egregiously than Keynsian economics.

To sum all that up some of the major axioms of classic economics, neo classic and Austrian are it seems to me wrong. The idea that if markets are left to themselves without interference then they are self regulating is pollyanna. The idea of trickle down is just false. The idea that government is bad free enterprise good again Pollyanna and at times egregious. Where they go awry is there attitude to and understanding of power. Left to its own devices wealth and power aggregates and accumulates to the few. There are very few examples in history that buck that trend. When they get powerful enough they influence the economic and political system to accelerate that accumulation by doing things like setting up central banks and insisting on free trade where it is an advantage to them and regulation when it is also an advantage to them. The corporations push to be deregulated and allowed ever more a free hand whilst pushing to make sure unions and the power of labour are regulated. When an economy is mature the powerful elite will start extracting wealth from the middle classes. That's power for you. And it is a blind spot in the classic, neo classic and Austrian schools, and which the Keynsians are maybe partially more aware, but only Marxism comes close to nailing.

[WinePusher]

The figure changes from country to country but roughly speaking about 95-98% of money is created by private banks as loans. They create the money out of nothing not the central bank. Recently the Bank of England admitted in a report that in the UK the banks create the loans before they have an asset to back the loan. So money really is quite literally created out of nothing.....by private banks.

Well yea that's correct but the central bank, in both your country and mine, controls the rate at which private banks create money.

Central banks have been with us for a long time so it is difficult to offer clear cut examples that can be said to be independent of the influences of central banking. But the Tulip mania of 1637 did not need the stimulus of a central bank. Whilst the presence of a central bank is sufficient for a business cycle it is not necessary.

Yes, I'd say you're pretty much correct Furrowed Brow but the key insight to take away from the Austrian school is not that recessions and panics would automatically disappear if we took central banks out of the picture. Rather, recessions and depressions would be less severe and more mild if we didn't have a central bank skewing the interest rate.

As much as the central banks can shoulder their share of the blame I see the present ongoing economic malaise the result of globalisation, how global companies now dominate the market place, the creeping fascism that goes with the accumulation of power and wealth to a few, and having economies dominated by fewer huge corporate entities; and how they are able to move capital and jobs freely around the world playing one county off against another and exploiting the differences in labour rates, taxation etc. We are going through a phase of history in which we are witnessing a race to the lowest common denominator. A downward trend largely due to a couple of billion cheap Chinese workers entering the international market place a couple of decades ago. But if central banks have accentuated that trend the alternative is decentralisation like the Bristol Pound.

Furrowed Brow, your objections to globalization don't make much sense. Nearly every single economist, including Paul Krugman, supports the free movement of goods, workers and capital across countries. This is the essence of globalization and it has brought about an increase in the standard of living for many poor and destitute countries particularly in Asia and Latin America. China has been one of the greatest beneficiaries of globalization because their ability to dump their products onto America and other countries has allowed their economy to grow at unprecedented rates. Yes, China does have issues with worker safety and pollution but these problems pales in comparison with the massive benefits they're receiving, which is all due to globalization.

To sum all that up some of the major axioms of classic economics, neo classic and Austrian are it seems to me wrong. The idea that if markets are left to themselves without interference then they are self regulating is pollyanna. The idea of trickle down is just false. The idea that government is bad free enterprise good again Pollyanna and at times egregious.

I wouldn't say that these are axioms. They're policy recommendations that were formulated based on what the laws and theories of economics state. Adam Smith pointed out that if we left people to their own devices and allowed them to pursue their own self interests, then they would ultimately produce socially optimal outcomes for the entire society. Based upon this insight is only makes sense to allow the market to be as free as possible rather than having a third party (the government) come in and tip the balance of power in favor of one person or another. Similarly, the idea behind trickle down is that a rising tide lifts all boats. If the government implements punitive taxation on the top 1% it will adversely affect those at the bottom and vice versa.

Left to its own devices wealth and power aggregates and accumulates to the few.

And this is why I can't ever take Marxists seriously. You're obviously very concerned that power and wealth is accumulated by only a few people under capitalism (while there is no evidence to back this claim) but you don't seem to care that much about the power and wealth accumulation that takes place under Marxist economies.

[Furrowed Brow]

Furrowed Brow, your objections to globalization don't make much sense. Nearly every single economist, including Paul Krugman, supports the free movement of goods, workers and capital across countries.

Nearly every economist including Krugman are part of the present paradigm. There is only one major system of economic thought that is critical of capitalism and that is Marxism. How big was the department on Marxism at the college you went to? As Marxist economist Richard Wolff now about 70 I think points out there was no such department when he went to college. He had to teach himself. I am not against pointing out where the consensus lies but I think we need to give some context to that.

Its not free trade per se that is the problem but who is empowered to trade. The factories workers in the US had no say when their factories were shut down and moved to China except maybe accepting Chinese wages. But I don't think Krugman likes the idea of major corporations parking themselves off shore - also an aspect of globalisation and free trade.

This is the essence of globalization and it has brought about an increase in the standard of living for many poor and destitute countries particularly in Asia and Latin America.

Well first we should ponder the history behind those poor standards of livings. We also have to ponder what is meant and what counts as free trade. An idealisation with tenuous connection to reality.

Trade – lots of it – and increasing trade – free or manipulated has improved the living conditions of billions of people. It has also reduced the living standards of billions. Here’s two ways to look at it.

• 1/ We’ll call this the Krugman Paradigm and it goes something like this: We in the West followed a path of industrialisation and capitalism and technological development and saw our standard of living rise. We look around the world and see a lot of poor people. We conclude that if they follow our economic models they too will find themselves on the path to prosperity. Some countries are able to do this on their own other poorer countries lack the capital. Therefore open trade and globalisation is a means to allow the rich nations to invest in these countries with confidence and that free trade will stimulate more trade and more trade is growth and rising living standards correlate to economic growth.
  
  I have to say I find this first paradigm very Pollyanna. I’ll adumbrate the alternative which I think is more realistic.
  
  2/ The West was the first to industrialise and enter a phase of capitalism. This gave the West and advantage which it exploited. Through empire and later neo-colonialism it went around the world with gun boats and bribes and made friend with the elites of the countries it dominated at the expense of the poor. The two largest empires were first Britain and who in the later phase handed the torch over to America, but France, Belgium, Holland, Italy, all had their empires. The West has for a couple of hundred years extracted wealth from the outer regions of its empires. This wealth improved the standard of living at the centre of the empire at the expense of the outer poor who saw no improvement or even a decline, and certainly saw any potential for improving their circumstances thwarted. The British empire was perhaps most successful because it was best at ensuring the elite and the middle classes of its colonies were personally invested in the empire to maintain their standard of living over the poor.
  
  In the 20th century the economic model applied widely was exemplified by Indonesia. Suharto put in place in a Western backed coup ensured wages in Indonesia remained low to provide a cheap work force for Western corporations. This was done by political oppression and massacring large parts of his population. Suharto also put his country into debt with the West - at the insistence of the West - on projects designed to for the elite classes in Indonesia, and after the fall of Suharto all that debt has fallen onto the nation and the poor. A debt the West still extracts. There was also another economic model applied. Due to the cold war three counties in particular were picked out by America as vital to their interests. These countries received massive investment, military bases and access to technology and patents. These countries were Germany, Japan and South Korea. This model came at the expense of America losing or weakening many of its own manufacturer sectors in favour of Germany, Japan and South Korea. Think cars and TVs. The Western elite continued to profit and grow rich from this arrangement but by the 70s we enter a period when the standards of living begin to plateau and then decline for the average worker. As the centre of the empire becomes more diffuse and the wealth it extracts goes to more areas the standard of living of the worker at the centre declines. The fall in living standards masked by first woman entering the work force and then by debt. The metric for rising standard of living for the working classes is not trade or economic growth but where they are located relative to the centre of the dominant trading empire. Globalisation means the Western empire has gone global or is increasingly going global and all the old advantages that accrued to those at the centre are dissipating with it. The rise of standards of living in China and the BRICS indicative of the rise of new power. China is already invested heavily in Africa and looks to be moving into South America over the next few decades it will become increasingly obvious these friendly arrangements have all the same old tells of neo-colonialism as China tries to raise the standard of living of its populations at the expense of the outer regions of its empire.
  
  So to sum all that up: if you are poor or part of the working classes in the West globalisation is the sign of the demise of our standard of living; ‘free trade’ as it is called is not going to relieve us of that decline. Trade by itself does not improve the standard of living of the poor and working classes. It does when they are situated closer to the centre of power. When there is asymmetric political power it is an asymmetric trading relationship. So yes hundreds of millions of Chinese have seen their standard of living rise but we in the West are seeing hundreds of millions of standards of livings fall. On the whole it is better for someone to be pulled out of subsistence living if we in the west have to go without a larger TV. But it is more pernicious than that, the decline in the West is being exploited and the powerful elite classes are readying for the political repression that will surely follow. They are not about to give up their power or their standard of living to share the wealth being accumulated to the 0.001%. There is also 10% of the population who also benefit and maybe another 30% percent who don't benefit or benefit minimally who have bought into that ideology. At the moment the Western politicians are trying to negotiate a softer landing but in the future we are all going to feel we are working in “Eastern Germany�. Globalisation and giving global corporations free reign accentuates that trend.

And this is why I can't ever take Marxists seriously. You're obviously very concerned that power and wealth is accumulated by only a few people under capitalism (while there is no evidence to back this claim)

Not quite. I am concerned how wealth and power accumulate under any system. The presented paradigm we live in is capitalism.
I’ll point you to every study in the last ten years on the subject showing the present trend of inequality in America and Europe. The tide has come in and the yachts are floating.

I'll point to the lack of societies without an elite class and without oligarchs.

I'd ask for the evidence that shows how capitalism prevents plutocracy.

I point you to study the history of the British empire, then in the 20th century the history of South America, Africa, Asia. Study Suharto and Indonesia. Take a look at the political and business families that have dominated the West for decades. Take a look at who really runs America and the US. Take a look at who held the power and wealthy in every empire. Take a look at the number of military bases maintained by America around the world compared to any other nation, and then go back and look at an old 1940s world Atlas and look at how much of the world used to be in pink.

Also take a look at what happens when empires decline; the wealthy elite indeed extract wealth at accelerating rate.

..but you don't seem to care that much about the power and wealth accumulation that takes place under Marxist economies.

No I’ll criticise that too. I would say Marx got a lot wrong but his system of thought is the only major political theory that is critical of capitalism and he had some important insights. My own personal view is that society is not static it ebbs and flows and there is always a struggle. Marx offers the prism of class struggle and I think that is right. I think economic systems that resist and put a break on the wealth and power accumulating to a minority are preferable and that resistance to that accumulation is vital for a healthy society. I also think that capitalism that relies on economic growth to improve standards of living is unsustainable and we eventually are going to be forced to find another way.

[Furrowed Brow]

Adam Smith pointed out that if we left people to their own devices and allowed them to pursue their own self interests, then they would ultimately produce socially optimal outcomes for the entire society.

Sorry I should have included this point first time.

Adam Smith's point is not a general truth and begs the question who gets to judge what is optimal

Example, factories owner in US sees his competitor move to China for cheaper labour costs. He is forced to also move. Good and services are now cargoes around the world contributing to pollution and global warming. In China and Asia villages are emptied as workers move to the cities. Often leaving behind families, parents leave children with grandparents, husband and wives separated for months on end. Back in the US manufacturing collapses and the average wage goes into decline. whilst the good coming out of China are cheaper initially offset that eventually the decline of wages destroys the home market. Workers find themselves increasingly relying on debt to make purchases previously they might have saved for or even paid for outright. China cannot provide its own workers the wages once enjoyed in the US because the US market will not sustain the necessary price levels because workers in the US no longer earn what they did. The factories wages in China begin to rise but the factory owner notices cheaper workers elsewhere and gets ready to move again.

All this is rational and the factory owners are only looking after their own self interest. But their self interest like a large stone dropped in a pool has more disruptive impact.

[WinePusher]

Furrowed Brow, your objections to globalization don't make much sense. Nearly every single economist, including Paul Krugman, supports the free movement of goods, workers and capital across countries.

Nearly every economist including Krugman are part of the present paradigm.

So what? Being apart of the current paradigm doesn't prevent or prohibit them from supporting and endorsing Marxism. That is the thing Furrowed Brow, if Marxism had such a great allure then it should've already captured and enticed mainstream economists but it hasn't. This is due to the fact that there hasn't been a theory so discredited and refuted like Marxism.

There is only one major system of economic thought that is critical of capitalism and that is Marxism. How big was the department on Marxism at the college you went to? As Marxist economist Richard Wolff now about 70 I think points out there was no such department when he went to college. He had to teach himself. I am not against pointing out where the consensus lies but I think we need to give some context to that.

At least two of my economics professors were self professed Marxists, including the chair of the department. Overall, the department was heavily bent towards Marxian/Institutionalist economics and focused more on teaching students about heterodox economics rather than mainstream, neoclassical theory. My labor economics class was entirely devoted to studying Karl Marx, literally all we did was read and write about Das Capital, and so were many other of my economics courses.

Richard Wolff's university, the University of Massachusetts Amherst, is heavily seeped in Marxism as are many other universities throughout America. The problem is that Marxian economics is confined to these institutions and has yet to penetrate into the mainstream which it has to do if it ever hopes to gain credibility. Take Richard Wolff for instance, imo he has said nothing profound about Capitalism nor has he made any damning argument in favor of Marxism. He is the intellectual equivalent to someone like Bob Murphy, an Austrian economist.

Its not free trade per se that is the problem but who is empowered to trade. The factories workers in the US had no say when their factories were shut down and moved to China except maybe accepting Chinese wages. But I don't think Krugman likes the idea of major corporations parking themselves off shore - also an aspect of globalisation and free trade.

Yes, a negative consequence of free trade is the temporary displacement of domestic workers who were employed in import competing industries. Once again, economists consider this a pretty weak argument against free trade because economists view the world in terms of trade offs. Higher employment at home, resulting from anti free trade policies, will have the effect of increasing unemployment in foreign countries and vice versa. The process of free trade allows for specialization and improves overall efficiency in an economy. Secondly, anti free trade policies, including tariffs and quotas, result in higher prices for consumers who end up supporting inefficiency domestic producers. Like Paul Krugman said, if there was ever a creed for economists it would surely include the phrase, 'I understand the principle of comparative advantage and I support free trade.'

And on the face of it, off shoring has a bad reputation. But if you actually look at the details off shoring is perfectly consistent with competition. If a business can relocate their production operations to a different country and pay cheaper costs then why shouldn't they? Because they have an obligation to keep their workers employed? Once again, if a business doesn't move to another country then yes, workers in the domestic country get to keep their jobs but workers in the country that the business was about to move to lose out on employment opportunities. Either way jobs are being lost.

In fact, off shoring is the primary reason why these underdeveloped countries are beginning to realize higher living standards. The fact that businesses relocate their operations to these underdeveloped countries allows for employment to be created for their citizens, and it allows for higher incomes and savings, etc.

This is the essence of globalization and it has brought about an increase in the standard of living for many poor and destitute countries particularly in Asia and Latin America.

Well first we should ponder the history behind those poor standards of livings.

Paul Krugman and Thomas Sowell, two renowned economists, have both stated that poverty and poor living standards have literally existed since the inception of human civilization. The human race was born in poverty, so it is both illogical and disingenuous to somehow suggest that global poverty is the result of capitalism and globalization.

We also have to ponder what is meant and what counts as free trade. An idealisation with tenuous connection to reality.

Free trade has been a topic of debate ever since the 1800s. There is no deep, secret and obscure meaning behind free trade. All it is is the free movement of goods across countries.

Trade – lots of it – and increasing trade – free or manipulated has improved the living conditions of billions of people. It has also reduced the living standards of billions. Here’s two ways to look at it.

• 1/ We’ll call this the Krugman Paradigm and it goes something like this: We in the West followed a path of industrialisation and capitalism and technological development and saw our standard of living rise. We look around the world and see a lot of poor people. We conclude that if they follow our economic models they too will find themselves on the path to prosperity. Some countries are able to do this on their own other poorer countries lack the capital. Therefore open trade and globalisation is a means to allow the rich nations to invest in these countries with confidence and that free trade will stimulate more trade and more trade is growth and rising living standards correlate to economic growth.
  
  I have to say I find this first paradigm very Pollyanna. I’ll adumbrate the alternative which I think is more realistic.

Precisely, you summarized the position very well. The formal name for what you just described is the classical theory of growth and stagnation.

2/ The West was the first to industrialise and enter a phase of capitalism. This gave the West and advantage which it exploited. Through empire and later neo-colonialism it went around the world with gun boats and bribes and made friend with the elites of the countries it dominated at the expense of the poor. The two largest empires were first Britain and who in the later phase handed the torch over to America, but France, Belgium, Holland, Italy, all had their empires. The West has for a couple of hundred years extracted wealth from the outer regions of its empires. This wealth improved the standard of living at the centre of the empire at the expense of the outer poor who saw no improvement or even a decline, and certainly saw any potential for improving their circumstances thwarted. The British empire was perhaps most successful because it was best at ensuring the elite and the middle classes of its colonies were personally invested in the empire to maintain their standard of living over the poor.

Ok, I admit that all of this is historically correct. Are you going to develop this into the argument that the west set back these countries, such as the ones in Latin America, by colonizing them? I'll have much to say about that if that is indeed your argument.

So to sum all that up: if you are poor or part of the working classes in the West globalisation is the sign of the demise of our standard of living; ‘free trade’ as it is called is not going to relieve us of that decline. Trade by itself does not improve the standard of living of the poor and working classes. It does when they are situated closer to the centre of power. When there is asymmetric political power it is an asymmetric trading relationship. So yes hundreds of millions of Chinese have seen their standard of living rise but we in the West are seeing hundreds of millions of standards of livings fall. On the whole it is better for someone to be pulled out of subsistence living if we in the west have to go without a larger TV. But it is more pernicious than that, the decline in the West is being exploited and the powerful elite classes are readying for the political repression that will surely follow. They are not about to give up their power or their standard of living to share the wealth being accumulated to the 0.001%. There is also 10% of the population who also benefit and maybe another 30% percent who don't benefit or benefit minimally who have bought into that ideology. At the moment the Western politicians are trying to negotiate a softer landing but in the future we are all going to feel we are working in “Eastern Germany�. Globalisation and giving global corporations free reign accentuates that trend.

If I understood you correctly, you're basically saying that the decline in economic prosperity of the west is the result of free trade? That's what the first sentence reads like. If you look at the data the United States is the second largest exporting country right behind China. This means that the United States is producing enough to satisfy not only domestic demand, but also international demand. This is somehow the cause the cause of all our problems in your mind? And I want to specifically address this quote:

On the whole it is better for someone to be pulled out of subsistence living if we in the west have to go without a larger TV. But it is more pernicious than that, the decline in the West is being exploited and the powerful elite classes are readying for the political repression that will surely follow.

I absolutely agree with your first sentence, but how is the our economic decline being exploited by the elite and why is there an economic decline in the first place, in your opinion?

And this is why I can't ever take Marxists seriously. You're obviously very concerned that power and wealth is accumulated by only a few people under capitalism (while there is no evidence to back this claim)

Not quite. I am concerned how wealth and power accumulate under any system.

And yet you champion Marxism. Furrowed Brow, it's not as if Marxism has never been tried. You're making it seem as if Marxism has never been implemented on a wide scale, which couldn't be further from the truth. Wherever Marxism has been tried it has failed, wherever Marxism has been tried there is also a huge disparity of wealth and power far more egregious than what we supposedly have under capitalism.

I’ll point you to every study in the last ten years on the subject showing the present trend of inequality in America and Europe. The tide has come in and the yachts are floating.

Inequality has always existed, and it existed before the 2008 collapse. Prior to the collapse the rising tide was lifting all boats, not just the yachts. Our current woes are not the consequence of inequality, they're the consequence of bad economic policies. You and others are exploiting the crisis and creating hysteria about inequality in order to expedite the coming socialist revolution that you all want. Didn't Marx predict that capitalism would eventually self destruct? It's been about 2 centuries, wonder when that's gonna happen.

[Neatras]

[Replying to post 2 by WinePusher]

That is incredibly kind of you! Having just finished my semester of macroeconomics (and sliding by with a chillingly low "C"), I'm quite eager to review and correct the imbalanced assumptions I made in the class using this as a potential source.

[WinePusher]

[Replying to post 2 by WinePusher]

That is incredibly kind of you! Having just finished my semester of macroeconomics (and sliding by with a chillingly low "C"), I'm quite eager to review and correct the imbalanced assumptions I made in the class using this as a potential source.

Lol it's all good. I got C's in a handful of courses throughout my time as an undergrad, mainly in those courses that held no interest for me like anthropology, art history, communications, etc. Just try to avoid getting C's in those classes that fall under your major.