Briefly discuss the role of assumptions in macroeconomics and demonstrate the us
ID: 1142154 • Letter: B
Question
Briefly discuss the role of assumptions in macroeconomics and demonstrate the use of ceteris paribus assumption in constructing the demand theory. (5 points) What does the circular flow diagram represent? What specific assumptions are we using in the simple circular flow diagram and what is (are) the main economic information that it is conveys? (5 points) In "The Macroeconomist as a scientists and engineer" (the reading assignment article), what do you learn about history of macroeconomics and what macroeconomists do? (6 points) According to the article mentioned in question #3, what is (are) the main difference(s) between Keynesian and Classical schools of economic thoughts? According to the article, is there a consensus on the approach to macroeconomics (a unified framework)? (6 points) Consider an economy that produces and consumes apples and oranges. In the table below are data for two different years. 1. 2. 3. 4, 5. Price of Apples (per kg) Price of Oranges (per kg) Apples Produced (kg) Oranges Produced (kg) Year 2000 $1.00 $0.75 1000000 1250000 2010 $5.00 $3.00 1500000 1500000 Using the year 2000 as the base year, compute nominal GDP, real GDP and the GDP deflator (implicit price deflator) for both years. (1 point) Calculate inflation rate (by what percentage has price changed?) (1 point) Compute a fixed-weight price index such as CPl in 2010 (2 points) a. b. 6. The natural rate of unemployment is is given aswhere U is the number of L S+ unemployment people in the total labour force, L; and s is job separation rate for employed people ( E ) and f is job finding rate for the unemployed (U). Using this model, explain how free trade, unions, employment insurance, and minimum wage laws affect the natural rate of unemployment while stating the possible policies (reforms) that could be implemented to mitigate the unemployment impacts of each of the items listed. (10 points)Explanation / Answer
1) Role of assumptions in macroeconomics is to make the models simpler and easier to understand. Also, the real world is complex and dynamic so to make things simpler and answer different questions regarding short and long term, economists make assumptions.
Ceteris paribus, which means other things remaining constant, is important in constructing demand theory because in the real world it becomes difficult to isolate all the different variables that affects the demand and price of a product. So to avoid other possibilities and understand the effect of each of the variables on price and quantity demanded, economists ignore all other possibilities or in other words they assume them to be constant.
2) Circular flow diagram is a graphical representation of movement of goods, services and money in the economy. In other words, it shows how an economy functions. It shows the interdependence and continuous nature of all economic activities and also serves as a tool for measuring national income.
The basic circular flow diagram (involving households and firms) is based on following assumptions -
a) The economy consists of two sectors - households and firms.
b) Households spend all of their income on goods and services or consumption and thus there are no savings.
c) All the goods and services produced by firms is purchased by households.
d) There is no financial sector and no government sector.
e) Economy is closed i.e. no exports and imports.
3) History of macroeconomics - Some economists considered macroeconomics as enginneering and some as science. Earlier, classical economists believed that monetary factors could not affect real factors. But then keynes developed a theory which was in contrast to earlier theories. He believed that there is tendency for people and businesses to save cash and reduce or avoid investment during recession period. This invalidated the assumptions of classical economists who said that markets always adjusts itself. Afterr keynes theory, more theories like Neoclassical synthesis, Neo-Keynesian models, Phillips curve, non-Walrasian theory evolved.
Macroecomists perform macroeconomics forecasting, analysises and research. They study how aggregate economy functions. Various variables like GDP, national income, inflation, aggrgate demand, etc are analysed.
4) Difference between classical and keynesian school of thought - Classical economics was founded by famous economist Adam Smith, and Keynesian economics was founded by economist John Maynard Keynes. Classical economic theory says that as needs of people ( individuals and businesses) arises, they adjusts to meet each other’s requirements and thus a self regulating economy is the most efficient economy and government intervention has no major impact. While Keynesian economics believes that government intervention is essential for the efficient functioning of an economy.
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