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Chapter 19: Q4. (page 404)

Craig and Kris were walking directly toward each other in a congested store aisle. Craig moved to his left to avoid Kris, and at the same time, Kris moved to his right to avoid Craig. They bumped into each other. What concept does this example illustrate? How does this idea relate to macroeconomic instability?

Short Answer

Expert verified

The given example illustrates the concept of coordination failure. The coordination failure leads to macroeconomic instability because of differences in the expectations in the wrong direction.

Step by step solution

01

Explanation of the example

Coordination failures occur when people fail to reach a mutually beneficial equilibrium because they lack a way to coordinate their actions. In the above example, Craig and Kris expect that the other one will move in the other direction and not the same and keep walking. But the expectations are entirely based on individual rather than coordination. So, they bump into each other.

02

In relation to macroeconomic instability

Suppose that individual firms and households expect other firms and consumers to cut back on investment and consumption. As a result, each firm and household will anticipate a reduction of aggregate demand, and the firms will reduce the aggregate. Consequently, there is instability in the form of unemployment and inflation. If there had been coordination among firms and households, instability could have been avoided.

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Most popular questions from this chapter

Use an AD-AS graph to demonstrate and explain the price-level and real-output outcome of an anticipated decline in aggregate demand, as viewed by RET economists. (Assume that the economy initially is operating at its full-employment level of output.) Then demonstrate and explain on the same graph the outcome as viewed by mainstream economists.

Place 鈥淢ON,鈥� 鈥淩ET,鈥� or 鈥淢AIN鈥� beside the statements that most closely reflect monetarist, rational expectations, or mainstream views, respectively:

a. Anticipated changes in aggregate demand affect only the price level; they have no effect on real output.

b. Downward wage inflexibility means that declines in aggregate demand can cause a long-lasting recession.

c. Changes in the money supply M increase PQ; at first only Q rises, because nominal wages are fixed, but once workers adapt their expectations to new realities, P rises and Q returns to its former level.

d. Fiscal and monetary policies smooth out the business cycle.

e. The Fed should increase the money supply at a fixed annual rate.

First, imagine that both input prices and output prices are fixed in the economy. What does the aggregate supply curve look like? If AD decreases in this situation, what will happen to equilibrium output and the price level? Next, imagine that input prices are fixed, but output prices are flexible. What does the aggregate supply curve look like? In this case, if AD decreases, what will happen to equilibrium output and the price level? Finally, if both input prices and output prices are fully flexible, what does the aggregate supply curve look like? In this case, if AD decreases, what will happen to equilibrium output and the price level?

According to mainstream economists, what is the usual cause of macroeconomic instability? What role does the spending-income multiplier play in creating instability? How might adverse aggregate supply factors cause instability, according to mainstream economists?

You have just been elected president of the United States, and the present chair of the Federal Reserve Board has resigned. You need to appoint a new person to this position, as well as a person to chair your Council of Economic Advisers. Using Table 19.1 and your knowledge of macroeconomics, identify the views on macro theory and policy you would want your appointees to hold. Remember, the economic health of the entire nation鈥攁nd your chances for reelection鈥攎ay depend on your selection.
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