Introduction to Macroeconomics;
Prof. H. Cleaver
FIRST TEST ANSWERS
Answer ALL the multiple choice questions by marking the correct answer on these pages. The correct answers are marked below with an asterisk
Answer FOUR essay questions, with no more than one question from each section.
Write your answers in a blue book and clearly mark, on the cover, which questions you have answered, e.g., II.1, III.2.
Part I: What is Economics?
Section A: Multiple Choice Questions
1. Neoclassical economics concerns itself with the determination of various prices. In the branch of Microeconomics, economists are concerned with _________, while in Macroeconomics they consider _________
a) price rises; price falls
2. Economists define opportunity cost as
b) real prices; nominal prices
*c) individual product prices; the aggregate price level
d) costs to consumers; costs to producer
a) the immediately available money price of goods and services
b) the best buy you can find
c) the time you must spend when shopping
*d) that which you give up when you make a choice
Section B: Essay Questions
I.1. a) What are the relative advantages and disadvantages of classical and neoclassical conceptions of economics? b) Given a choice which would you take as your point of departure for building your own ideas about the economy? Why?
a) Relative advantages of the classical conception: its focus on production draws our attention to the centrality of work in capitalist society. It therefore includes considerable analysis of such subjects as the division of labor, productivity, the impact of technology on workers' welfare, and so on.
Relative advantages of the neo-classical conception: its focus on choices opened it to looking outside what was traditionally called the "economy" at social sectors such as the family and education.
Relative disadvantages of the classical conception: by focusing on the factory and on market exchange, it pretty much ignores all other social spheres, even though they may be intimately linked to the "economy" as it understands it. Thus the definition is too narrow.
I.2. Assuming economics is what economists do, how would you compare and contrast the economics of classical theories of economic adjustment and the economics of John Maynard Keynes's response to the Great Depression. (Note: I am not asking you to explain their theories, but rather, I'm asking you to talk about what we might say about the general character of "economics" as implied by their theories.)
Relative disadvantages of the neo-classical conception: the focus on choice, especially market choice, has resulted in very little attention to work and the sphere of production. Thus even as it has sought a general formulation of the "economic question" it has narrowed its range of attention in important ways.
b) Which point of departure and why? Obviously there are at least two and maybe more answers possible. The point is not just to choose one, but to construct some interesting reasons for doing so --or for rejecting both perhaps. "I prefer one" or the other is not enough. The "why" part of the question must also be answered. Nor is enough to tell me what you think I want to hear. If you have been paying attention, you know that I would probably prefer the classical approach because of the advantage mentioned above. But if you agree with me, you must have reasons. Note: the question asked about your "point of departure" not whether you would simply choose one over the other. Therefore it is quite possible to talk about taking one as a point of departure but then adding in elements of the other, or of something else for that matter --perhaps from other disciplines.
Comparison: both the classical economists and Keynes (and his followers) constructed theories, this was part of what they "did", building theories was part of their practice. Also, they undoubtedly looked at the world and considered their theories the light of what they observed. So they probably had an empirical side in common as well as a theoretical one. We know that classical theory included (from what we have seen in class) the labor market, the final goods market and the financial market (market for loanable funds). Keynes also looked at markets and also considered those markets to have tendencies toward equilibrium. Indeed, Cleaver points out that his macroeconomic models of the aggregate economy also is constructed around an analysis of forces tending toward equilibrium.
Contrast: where they seem to have differed is in the relationship they saw between their theories and state policies. Whereas the classical theorists thought that their theories justified a "laissez-faire" policy, i.e., the state would only act to guarantee the free working of the markets, Keynes' theory argued for a much more proactive role for the state. In Keynes theory equilibrium might only be achieved by the free market at socially and policially unacceptable levels of unemployment and therefore government was justified in intervening to effect a more acceptable equilibrium, i.e., one with much lower levels of unemployment. In general, the classical theorists claimed unemployment was not a problem, merely a passing phenomenon associated with labor market adjustment toward full employment (that is to say when markets clear and all who want jobs at the going wage find employers who want to hire them at the going wage). But for Keynes, high levels of unemployment could no longer be viewed in this manner. Already in the 1920s when the British were contemplating a return to the gold standard after World War I, he saw that the levels of unemployment that would result would be socially unacceptable and politically dangerous. His classical opponents pooh-poohed his views. In fact when the British did return to the gold standard, unemployment shot up and the English working class reponded with the General Strike of 1926 --the first in history. Again in the Great Depression, the classical's said "hold tight", Keynes said "the governemnt must take responsibility for creating the employment the private sector won't". He was proved right, governments did and the Depression was overcome.
Part II: Variations in Capitalist Economies
Section A: Multiple Choice Questions
1. According to our class discussions, the economies of the U.S.A. and the U.S.S.R.
a) were complete opposites
2. In discussing the "economic problem," Case & Fair say that, given scarce resources, large complex societies attempt to answer three basic questions. Which of the following is NOT one of the three?
*b) each used both markets and planning
c) can not be compared to each other because of their different forms of economic organization
d) were an interesting contrast because one was strcitly a market economy and the other strictly a
*a) How much will be produced?
b) What will be produced?
*c) How will it be produced?
d) Who will get it?
Section B: Essay Questions
II.1. Explain the problems in setting up a dualism between the U.S. and Soviet economies in terms of markets and planning.
First: as noted during the test "bipolar dualism" is redundant. Both words mean the same thing. Probably "bipolar" should have been deleted. Second, the point is that the dualism in question is that between the U.S. economy which was considered a more or less free market economy and the USSR economy which was considered the prime example of a totalitarian regime based on central planning. Third, "in setting up" means "conceptualizing" so the question concerns the problems with thinking about he structure of the Cold War world in terms of what were conceived of as polar opposites: market vs plan. There is quite a bit of this dualism in Case & Fair, but Cleaver argued in lectures that the bipolarity was by no means clear cut. This, he said, was because there were in fact markets in the Soviet economy and planning in the US economy. The examples he gave of the former included labor markets where workers could look for work with better wages and working conditions as a general rule (exceptions existed, especially in the defense industries --where they were already paid better anyway) and in interfirm relationships where deals were cut independently of the plan. Indeed, he argued the "plan" was never all that detailed anyway and informal markets were necessary to guarantee its success. The examples of planning in the US included large scale corporate planning and state planning. He argued that all giant multinational corporatins plan their own growth and development --it is not left to markets to settle intrafirm exchanges-- and that many of these firms are larger than many countries. So the planning is on a very large scale. He also argued that the US government has long been involved in planning, most obviously since the onset of Keynesian economic policy making which amounts to a kind of aggregate planning of output and unemployment, but also the state has always had various "industrial policies" --most notably the defense industries in the Post WWII era. There are other examples such as the planning of the interstate highway system, TVA, the nuclear power industry and a wide variety of policies that determine what happens in various industries (e.g., energy, rail, agriculture). Once we recognize these kinds of things, then the clear cut juxtaposition of the US and Soviet economies by market and plan focuses our attention in a way that obfuscates a great many of the similarities between the two kinds of economic management.
II.2. Assume that Cleaver's definition of capitalism --a social system organized through the subordination of most of life to work-- applied in the socialist countries. What kinds of problems would you expect to find in the current "transition" in Russia and Eastern Europe?
Assuming the ex-Soviet socialist countries were some kind of "state capitalism", they were characterized by similar kinds of antagonisms and conflicts as the countries in the West with the added conflicts of those characteristic of totalitarian governments. That is, because the central government has assumed official responsibility for the whole economy, directly or indirectly, all the antagonisms of that economy would ultimately be directed at the government. Now with totalitarianism, where a police state makes ordinary Western-style conflict less likely, e.g., strikes and protests by workers, or even two-sided collective bargaining, the conflicts would pass underground to become endemic but hidden. Cleaver's argument suggests that such endemic resistance denied those economies the cooperation and hence most of the productivity of the labor forces involved, thus their chronic lagging behind the West, the growing gap in standards of living and ultimately the rising of their populations against the central state. Now the so-called "transition", as Case & Fair make clear, is a transition from more state decision making to less, and from the market as a secondary, highly managed, institution to a more important one with less management. Moreover, it means a reduction in the kinds of welfare-state support the state had provided to the workers. In other words, the transition is focused on bringing into play a new set of institutions designed to overcome precisely the kind of resistance which had been omnipresent in the old socialist economies: the refusal to work hard and well, the refusal to hand over one's creativity and inventiveness to the state. The role of the market in transition is double-edged, both offering rewards (higher wages for higher productivity) and punishment (high unemployment for non-competitive work performance). The opening of the ex-socialist economies to international trade pits the workers of the Western countries (whose products are now importable) directly against what had been protected workers (protected in the trade sense). How will it go? That will depend on how the workers in those countries adapt to the changing institutional environment and a new set of pressures and constraints. So far the process has been full of conflict both between the governments and the people and within the governments as state planners have differed over the optimal strategy to pursue.
Part III: The Market
Section A: Multiple Choice Questions
1. All of the following are determinants of a good's Demand EXCEPT
a) income and wealth
2. The Struggling Student Beer Company begins selling beer in Austin at the same time that the Daily Texan prints the results of a series of scientific studies which indicate that drinking beer can improve students' health and help them study. What is likely to happen in the beer market in Austin?
b) prices of other goods and services
c) tastes and preferences
*a) The demand curve and the supply curve will both shift to the right, and the equilibrium quantity
of beer will increase.
b) The demand curve will shift to the right, the supply curve to the left, resulting in an increase in
the equilibrium price and no change in quantity
c) Demand increases, supply increases, and there is no change in equilibrium price or quantity
d) Demand increases and supply decreases, resulting in a higher equilibrium price and quantity
Section B: Essay Questions
III.1. By the end of the 1960s it was apparent that the traditional American trade surplus was steadily declining. In the Spring of 1971 U.S. imports exceeded exports for the first time in decades. In 1972 the U.S. government intervened in international grain markets in order to raise the value of U.S. exports. It did so 1) by allowing a secret deal between the big grain exporting firms and the Soviet Union for enormous quantities of U.S. grain and 2) by using the power of the Department of Agriculture to restrict grain production in the U.S. a) Using supply and demand analysis (words and graphs) show how such actions raised the value of U.S. exports. b) Would the elasticity of the demand for American grain have any impact on the the efficacy of these interventions?
a) The grain deal, by adding a new very large buyer to the usual range of foreign customers, would cause a shift in the demand curve to the right. This would, ceteris paribus, cause an increase in price and an increase in sales. (see fig 1) The restriction of grain production in the US would cause a shift in the supply curve to the left (I say left rather than up because it would amount to holding land out of production, not necessarily in raising the costs of production) which would, ceteris paribus, cause an increase in price and a reduction in sales. (see fig 2) Putting these two changes together, the object was obviously to achieve both an increase in prices --guaranteed by both policies and magnified by their complementarity-- and an increase in sales in such a manner that the total value of grain exports would rise, thus contributing to the value of US exports and a reduction (ceteris paribus) in the trade deficit. (see fig 3)
III.2. Behind the demand curve in any market lie a whole set of assumptions necessary to its mathematical derivation and to the theory of its meaning. Spell out those assumptions and the roles they play in the determination of market demand curves. Then explain as much as you can about how changes in those assumptions would change the curves.
b) the elasticity of demand would definitely have an impact on the success of these policies. The elasticity of demand measures the responsiveness of demand to price. The elasticity of demand, call it e = %ÆQ/%ÆP. In the case of both of these policies (separately and together) there will be a change in price and therefore a change in the quantity demanded, thus in the total value of grain produced and sold. Since in all cases we can assume a downward sloping demand curve, an increase in price will result in a reduction in grain output Q, ie. e<0. Now the impact of the policies will depend on e in the following ways: 1) the restriction of output will lower output (shift supply to the left) while raising price. What the effect will be will depend on e. If e>-1, i.e., the demand is inelastic, then total revenue would rise as say a 10% increase in price was less than offset by a 5% decrease in sales. If e = -1, i.e., demand has unitary elasticity, the value of sales would remain the same. If e <-1, i.e., demand is elastic, it would fall as say a 10% increase in price was more than offset by a 20% fall in sales. 2) what would happen with the increase in demand would depend on the elasticity of supply, about which we have been told nothing. 3) what would happen with a combination of increased demand and restricted supply would depend on the elasticity of both demand and supply as well as on the magnitude of the relative changes, about which, again, we have been told nothing. Clearly policy makers were hoping (or estimated) that the net effect would be to raise prices.
Spell out assumptions and roles: the following things were mentioned in class: The market demand (the question concerns "the demand curve in any market") is obtained by adding up the quantity demanded by all consumers at every price, therefore it depends on all the assumptions made about individual behavior in the market in question. The derivation of the curve for an individual depends on a set of consumer preferences based on the choice rules: either A is prefered to B, B to A or the chooser is indifferent; the consumers decide purely on the basis of their own personal choice with no regard to others' consumption or how their own consumption would affect others --this Cleaver called a modeling of the sociopathic personality, i.e., of an ammoral person who cares nought for anyone else or social welfare (in the usual derivation of the curve Cleaver said choice is posed in terms of utility and utility maximization --but we weren't explained how that derivation was done); a given level of demand also depends on the level of income available to an individual to be spent on consumption goods and therefore a) demand for a given good depends on the prices and desireability of other goods --complementary and substitutes, and b) the demand in particular markets will depend on the distribution of income among individuals with varying degrees of interest in a given market. Cleaver emphasized that need does not necessarily imply demand, e.g., many can need and want food but not be in the market because they have no money, and therefore their "need" has no impact on the market demand.
Changes in assumptions: going down the list above: its hard to see how the derivation of market demand could not the simple sum of the quantities demanded --but we could imagine that there is some interaction among the various individual demands. This means that we have a non-sociopathic model of individual choice and the choices of individuals would be related to each other, how the curve might be changed would depend on the assumptions made about the interrelationships. For example, if we assumed that something like a "snob effect" held, then a rising price might result in more rather than less demand among some consumers and if others, following their lead jumped on the bandwagon, we could imagine that the quantity demanded might actually increase as price rose. Clearly a change in income distribution will affect the structures of demand as income is redistributed according the the varying differences in various consumers preferences. If we violate the choice rules, for example, accept the idea that some things are not comparable, not only is A not prefered to B but the two are never even considered in the same thought, then the pattern of behavior changes and the curves must change, but how is not obvious --figuring out how might take a formal derivation. This would obviously affect the issue of substitutes and complements which whose relationship would be cease to be. In all cases if there is an increase or decrease in income (given the distribution) we could assume that demand would increase or decrease accordingly.
Part IV: Economic and Social Crisis
Section A: Multiple Choice Questions
1. The field of economics that is now called Macroeconomics grew out of the era of the Great Depression, which saw the economy experience a prolonged downturn and persistent high unemployment. Classical economics could not explain these problems because its models assumed all of the following EXCEPT
a) prices are flexible
2. During the downturn portion of a business cycle, the economy is characterized by
b) recessions were self correcting
c) wages would adjust in the labor market, thereby eliminating unemployment
*d) the government should intervene in the economy
a) rising unemployment and rising investment
b) falling unemployment and falling output
c) rising profits and falling wages
*d) falling output and rising unemployment
Section B: Essay Questions
IV.1. Contrast Case & Fair's treatment of the business cycle with Cleaver's arguments about both traditional and Keynesian cycles as management of antagonism.
Case & Fair's treatment of the business cycle, at least what we have seen so far, has only concerned the fluctuations in economic variables. They describe the business cycle, its ups and downs, and tell us a little about how various variables change, e.g., unemployment goes up during a downturn or the general underlying trend of total output is up despite the ups and downs, but not much about the forces driving the cycle.
IV.2. Discuss the argument that the "economic" relationships that determine fluctuations in variables such as investment, unemployment, wages and profits are rooted in, and dependent on, a broader set of social institutions and relationships.
Cleaver on the other hand provides us with a fairly detailed analysis of those forces. Whereas Case & Fair say simply that classical economists thought that business cycles were self-correcting, Cleaver provides a whole analysis of why they thought so, how their theory led them to that conclusion, e.g., the dynamics of labor markets, goods markets and capital markets. He also provides a separate analysis based related to his discussion of growth that relates the mechanism of the cycle to the dynamics of antagonism between labor and business. This involves both the business response to wage increases exceeding productivity increases during upturns, i.e., a strike on investment inducing a downturn, and the shifts in power this causes , i.e., labor loses, business gains, which lay the basis for a new upturn. With respect to Keynesian "cycles" Case & Fair haven't said much in what we have seen other than Keynesian economics was aimed at managing aggregate demand and growth and Cleaver has said much the same thing only telling us more about the underlying principles, i.e., productivity deals at both the micro (collective bargaining) and macro (fiscal, monetary, industrial policy plus Bretton Woods) levels. In Case & Fair the discussion of policy making puts less emphasis on "antagonism" than does Cleaver who puts it at the very center of the social dynamics "economics" analyses.
The argument is Cleaver's and it runs something like this: the business organization of life around work has come to involve not only what goes on in the office, factory and field with wage labor, but also such unwaged arenas as the family, the school, the city streets, the ballpark etc. All of these institutions are organized and managed to some degree to create and recreate the ability and willingness to work, and therefore any crisis or rupture in these broader social institutions and relationships will have an impact on the kind of "economic" relationships, ie., those in the sphere of production, that determine changes in investment, unemployment etc. If we take his analysis of the business cycle and moving according to the rhythm of the relationship between wages and productivity and hence profits and investment, we can see how he can argue that changes in other spheres might affect this rhythm, e.g., the revolt in the streets of the 1960s was carried into the factories by young workers, the resistance to authority in the school and family also carried into the sphere of production all causing a slowdown in the growth of productivity and perhaps an acceleration of wage increases, thus the quicker emergence of falling profits.
"Discuss" means not only spell out the argument but to also evaluate it in some way. Many answers are possible. Here is one. While all of these relationships are plausible, a key issue must be the relative size of the effects. It becomes obvious that in economic analysis a given change in a variable may be due to a variety of other changes, but which of those other changes has the greatest effect? Some such changes might have diametrically opposed effects, i.e., one pushing a variable up, another pushing it down. Which will have an effect that overrides the other? Broadened from the economy to society more generally we can pose the same question: just how strong are the effects that Cleaver is talking about? Are they marginal and relatively unimportant or large and very important? Cleaver obviously thinks they are very important or he wouldn't spend time on them. Mostly, however, he just asserts this with not what you would call a wealth of empirical evidence of the size of the effects. More information would be useful to evaluate the issue.
Part V: Growth and Accumulation
Section A: Multiple Choice Questions
1. According to our discussions in class, the international system established at the Bretton Woods conference in 1944 was predicated on the assumption that:
*a) domestic governments were able to handle the neccesary adjustment when their exports and
imports did not balance
2. The Keynesian productivity deal:
b) all countries were willing to participate in international trade
c) the dollar would maintain its value
d) none of the above
a) called for the active intervention of the state to stimulate growth in productivity and output
b) linked increases in wages to increases in productivity so that wages and profits could both rise
c) was a response to domestic and international crisis
*d) all of the above
Section B: Essay Questions
V.1. a) Explain the classical analysis of markets that would justify Say's Law under the condition that workers earned enough to have savings, i.e., that in each period not only might firms have unspent profits but workers might have unspent wages. b) in what ways did the classical analysis of the species-flow mechanism amount to an extension of that theory to the international level?
a) the analysis justifies it by assuming that the capital market will function efficiently to to redistribute any wagtes that are not spent on final goods to those who WILL spend them on final goods, i.e., investors who will borrow the saved funds and spend them on means of production, i.e., plant and equipment, raw materials. This is enough because they also argued that the dynamics of all other markets, e.g., final goods markets and labor markets would be such as to "clear", i.e., everything that was brought to market would be sold. Their analysis focused on capital markets supplied primarily by business savings, but the logic would be the same in the case those savings (out of profits) were supplmented by saved wages --or any other form of saved income for that matter.
V.2. Keynesian macroeconomics is usually thought of by economists as justifying a "demand management" approach to economic policy via the use of monetary and fiscal policy. Discuss the appropriateness of this characterization in terms of both a) the policies used to fight depression and b) the policies used to correct international trade deficits under Bretton Woods regime of fixed exchange rates.
b) the species-flow mechanism (based on gold flows) would tend to restore balance in imports and exports. Although any given exported good might be competing with domestic goods elsewhere in a given market, most economists --especially in the classical period-- thought of imports and exports as a kind of international market. The equality of the value of a country's imports and exports would amount to the market having cleared. If a country tried to export but import less then gold would flow in, raise the price level, lower interest rates and the result would be stimulated economic activity and more imports. Thus the species flow mechanism was seen as a kind of market clearing device that could keep international trade/markets in balance.
a) The appropriateness of viewing K. macro as "demand management' in the case of fighting depression: in so far as Keyensian policies supported an expansion of the wage (and thus of consumer demand) and of government expenditures (also to stimulate further output by increasing final demand) the view would seem to be appropriate because at both the micro and macro level the policies pursued involved a conscious effort to expand (one kind of management) aggregate demand. On the other hand, from what we have seen and heard about the anti-depression policies, Keynesian policies go much further than this, they also stimulate supply by stimulating investment in plant and equipment that can expand output. While investment expenditure is clearly a kind of "demand" it also results in increases in supply quite directly --whereas increased consumer or government demand only stimulates increases in supply indirectly. This said, it is clear from what Cleaver has said about Keynes' preoccupation with unemployment that his "demand management" was aimed at increasing output and employment with it, and thus reducing unemployment.
b) The appropriateness of viewing K. macro as "demand management' in the case of policies used to correct international trade deficits under Bretton Woods regime of fixed exchange rates: Trade deficits involves an excess of imports over exports. The use of fiscal and monetary policies, according to Cleaver (we haven't yet seen how this works) to depress the economy would slow down the growth of imports --bring it back in line with the growth of exports-- due to reduced ecnomic activity. This would certainly involve reduced demand --from the government in the first instance, from others later perhaps as a result. Thus the view would seem appropriate. Now it is also possible that the government might also pursue "supply" policies, e.g., stimulating research and development investment that could lead to improved, lower priced and more competitive exports which would also act to bring imports and exports back into line. In this case, once again, "demand management" seems inadquate as a descriptor of the nature of the policies.