Macroeconomic Equilibrium, Unemployment, and Fiscal Policy
Macroeconomic Equilibrium and Price Levels
2 – What is macroeconomic balance? What happens if the price level is higher than the balance?
The macroeconomic balance, where real GDP and the general price level meet the demands of buyers and sellers, occurs at the intersection of the aggregate supply and demand curves, point E.
Frictional Unemployment: Classical vs. Keynesian Views
3 – Is there a single explanation for frictional unemployment? Explain the causes according to Classical and Keynesian economists.
Classical economists attribute unemployment to labor market imperfections and rigidities, particularly workers’ desire for wages above equilibrium. Labor laws and union pressure prevent wage reductions, even with high unemployment. For them, unemployment above the frictional level is voluntary, due to inadequate wage policies.
Keynesians, however, believe unemployment is involuntary, caused by insufficient aggregate demand (AD). They argue that increasing AD through expansionary policies would boost employment. However, this can also increase the price level.
Demand-Pull vs. Cost-Push Inflation
4 – Discuss demand-pull and cost-push inflation. Which is worse? Do we have demand-pull or cost-push inflation?
Demand-pull inflation arises from increased aggregate demand, leading to higher real output and prices. Cost-push inflation results from increased production costs, shifting the aggregate supply curve upward.
State Intervention and Public Sector Budget
2 – Describe the position of classical economists on state intervention in the economic system.
Classical economists believed that market forces automatically adjust the economy, making state intervention unnecessary. Keynesians later criticized this view.
Public Sector Budget and Its Role
3 – Discuss the public sector budget and possible situations. Justify why the budget is an instrument of economic policy.
The public sector budget outlines spending plans and revenue sources. It is calculated as: PUBLIC SECTOR BUDGET = Revenue – Public Expenditure.
- A budget surplus occurs when revenues exceed expenditures.
- A budget deficit occurs when expenditures exceed revenues.
- A balanced budget occurs when revenues equal expenditures.
Revenues are funds used to meet public sector objectives, while public spending is the set of payment obligations.
Fiscal Policy Effects on Output, Employment, and Prices
4 – Analytically and graphically explain the effects of a restrictive fiscal policy on output, employment, and prices.
Expansionary fiscal policy (increased spending or tax cuts) boosts production, employment, and prices. Restrictive fiscal policy (tax increases or spending cuts) slows production, employment, and prices.
Expansionary fiscal policy shifts the AD curve to the right, increasing production and prices in the short term. However, long-term positive effects may disappear due to inflationary pressures. Restrictive fiscal policy shifts the AD curve to the left, reducing production and prices.
Types of Deficits
5 – What are the types of deficit? Explain each.
The structural deficit is not due to cyclical fluctuations but to a mismatch between government revenue and expenditure structures. While the cyclical component of a deficit disappears when an economy recovers from a recession, the structural deficit remains.