[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Review and Practice
SUMMARY
1. Macroeconomic equilibrium focuses on equilibrium
levels of aggregates: employment, output, saving, and
investment.
2. The real wage equates the demand for labor with the
supply of labor. Increases in labor supply at each real
wage are reflected in lower real wages, which induce
firms to create additional jobs to match the increases
in supply.
3. The full-employment level of output is that level of
output which the economy can produce with its given
stock of plant and equipment, when labor is fully
employed. It will increase with increases in the labor
supply or as a result of new technologies.
4. The real interest rate (which takes into account inflation)
equates investment and saving. The desired level of
investment decreases with increases in the real rate of
interest. Household saving depends on income and the
real interest rate. When the economy is at full employment,
the interest rate is the main variable of concern
in determining saving. Saving increases slightly with
increases in the real interest rate.
5. A decrease in saving leads to a higher real interest rate
and lower investment. A decrease in investment at each
real interest rate leads to an unchanged or lower level of
investment, depending on the elasticity of saving.
6. An increase in saving leads to a lower real increase rate
and to increased investment. An increase in investment
at each real interest rate leads to unchanged or higher
investment, depending on the elasticity of saving.
7. When saving and investment are equal, the demand for
goods and services will equal the level of output at full
employment. The capital market balances leakages and
injections in the circular flow of income.
8. All the markets in the economy are interlinked. Changes
in one market have effects in all other markets.
KEY TERMS
full employment
short-run aggregate production function
potential GDP
full-employment level of output
loanable funds market
disposable income
real rate of interest
financial investments
capital goods investment
investment function
REVIEW QUESTIONS
1. How do competitive markets with flexible wages and
prices ensure that labor is always fully employed?
What induces firms to create just the right number
of additional jobs to match an increase in the number
of workers?
2. Describe the effects of changes in labor supply on equilibrium
real wages and potential GDP (full-employment
level of output).
3. What determines the economy’s productive capacity
or aggregate supply or potential GDP? How
does aggregate supply increase when labor supply
increases?
4. What is investment? Why does investment decrease
when the real interest rate increases? What role do
expectations play in investment?
5. What determines the level of saving? Explain why, if
taxes are fixed, disposable income in a full-employment
economy is fixed. Explain why saving may not be very
sensitive to the real interest rate.
6. How are leakages and injections balanced? Why will
demand and supply in the product market be equal if
leakages and injections are equal?
PROBLEMS
1. In the text, we assumed that the labor supply did not
depend on the real wage. Assume that at higher real
wages, more individuals wish to work. Trace through
how each of the steps in the analysis has to be changed.
Show the equilibrium in the labor market. What happens
to real wages, employment, GDP, and saving if the
labor supply function shifts to the right?
REVIEW AND PRACTICE ∂ 543