ADDIS ABABA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

Department of Accounting & Finance

Macroeconomics individual assignment

Name. ID NO.

TAMIRU TADESSE UGR/7458/15

SECTION 5

Submitted to : Instructor KALEAB

Submission Date: 27/04/2016 E.C

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 1) Macroeconomic policies are implemented to achieve the government's main objectives,
namely full employment and a stable economy through low inflation. We can use the Phillips
curve as a tool to explain the trade-off between these two goals. The Phillips curve describes the
relationship between inflation and unemployment in an economy.

Fig 1. Phillips
curve

The Phillips
curve model illustrates the inverse relationship between unemployment and inflation. According
to the model, inflation tends to be high when unemployment is low and vice versa. When the
unemployment rate is very low, workers have market power that allows them to raise wages. A
higher wage rate means production costs are high, so seller prices are higher, which means a
higher inflation rate. When the unemployment rate is very high, workers do not have much
bargaining power; they would rather accept a lower salary to get a job.

A.W. Philips found that a stable curve represents a trade-off between inflation and
unemployment and that they are inversely/negatively related.

In the scenario you've described, if the fiscal stimulus plan successfully lowers unemployment
but also raises inflation, it demonstrates the trade-off predicted by the Phillips Curve.

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 The Phillips curve has been used in macroeconomic policy analysis, suggesting that
policymakers can choose different combinations of unemployment and inflation rates. This
suggests that if governments want to reduce unemployment, they will have to accept higher
inflation as a trade-off. This trade-off suggests that policymakers face a difficult choice when
trying to balance these two goals. When the government takes measures to reduce unemployment,
such as increased government spending or tax cuts, it can stimulate demand in the economy,
leading to more jobs and a decrease in unemployment. However, this increase in demand can
also lead to rising prices and thus inflation.

Policymakers face difficult decisions as they often have to choose between prioritizing low
unemployment or low inflation. If they focus too much on reducing unemployment, they risk a
rise in inflation, which could weaken consumers' purchasing power and lead to further economic
imbalances. On the other hand, if controlling inflation becomes a priority, it could lead to
increased unemployment due to the implementation of policies that slow economic growth.

It is difficult to find the right balance between these two objectives because the relationship
between unemployment and inflation is not always stable and can be influenced by many factors
such as productivity growth, expectations and global economic conditions. To achieve a
sustainable economic outcome, policymakers must carefully consider the potential consequences
of their decisions and weigh the trade-offs between these competing goals.

The relationship we discussed above is a phenomenon in the short-run. But in the long run, since
unemployment always returns to its natural rate, there is no such trade-off.

2) The New Classical School and the New Keynesian School are two prominent schools of
thought in macroeconomics, each with their own models, assumptions, and policy implications.
We intend to compare and contrast the models, assumptions and policy implications of these two
schools of thought.

Models

New classical school:

 The new classical school is based on the theory of rational expectations, which assumes
that individuals and firms have rational expectations about future economic conditions. It

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 emphasizes the role of supply side factors and focuses on the long-term sustainability of
the economy.
 It basis on models of market equilibrium in which supply and demand adjust quickly and
assume that wages and prices are flexible. This assumes that
Individuals and companies act rationally and have perfect information.
 The main model used in the new classical school is the Real Business Cycle (RBC)
model, which emphasizes the importance of technological shocks and the effectiveness of
market mechanisms in determining fluctuations in production and employment.

New Keynesian

 New Keynesians believe that market equilibrium models cannot explain short-term
economic fluctuations.
 They base their models on the integration of elements of imperfect competition and rigid
wages and prices, which also explain the existence of involuntary
Unemployment. It emphasizes the role of demand factors and focuses on short-term
fluctuations in the economy.
 The main model of the New Keynesian School is the dynamic stochastic general
equilibrium model (DSGE), which combines microeconomic fundamentals with nominal
rigidities.

Assumptions

The new classical school assumes that markets are efficient, that individuals are rational, and that
government intervention in the economy is often ineffective and can lead to unintended
consequences. It is also assumed that markets will quickly become efficient and transparent,
eliminating short-term fluctuations.

The three most important working assumptions of the new classical school are;

1. Maximize economic agents: Households and companies make optimal decisions by using all
available information to make decisions, and that those decisions are the best possible ones given
the circumstances in which they find themselves.

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2. Expectations are rational in the sense that, statistically, they represent the best predictions
about the future that can be made based on the information available.

3. Clear markets: Prices and wages adjust to balance supply and demand.

The new Keynesian school assumes that markets are not always efficient and that market failures
can occur that require government intervention. It also assumes that individuals and companies
do not always have perfect information or make rational decisions and that frictions such as price
fixation and market failures occur in the economy.

In general, the working assumptions of the new Keynesian schools of thought are:

1. Some companies have market power through increasing economies of scale or monopolistic
competition.

2. Prices and wages remain stable in the short term even with rational expectations and better
microeconomic fundamentals, prices and wages can adjust slowly and it leads to price and wage
rigidity.

3. AS shock absorbers are important: severe recessions require government intervention to move
the economy toward “higher-level equilibrium.”

Policy implications

The new classical school advocates policies that favor free markets, limited government
intervention, and a focus on long-term economic stability.

1. Emphasis on free markets: They support minimal government intervention in the economy
because they believe that markets are efficient and self-correcting in the long run.

2. Limited role of government: Adopts discretionary fiscal and monetary policies and favors
rules-based policies aimed at long-term economic stability.

3. Supply-side policies: supports policies that promote economic growth through measures such
as tax cuts, deregulation and cuts in public spending.

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 The new Keynesian school advocates countercyclical measures such as currency
adjustments, interest rates, and fiscal stimulus to stabilize the economy, production, and
employment during times of recession or high unemployment.

1. Countercyclical policy: Supports discretionary fiscal and monetary policy to stabilize the
economy during recessions, such as; increasing government spending and lowering interest rates.

2. Market regulation: Recognizes market failures and the potential for market failures and
supports government interventions to address problem.

3. Long-term objectives combined with short-term stabilization: Recognizes the importance

of long-term economic stability, but emphasizes the need to manage short-term fluctuations
through active policy measures.

In the context of resolving macroeconomic instability in developing countries like

Ethiopia, I believe that the New Keynesian model has more applicable. Because Developing
countries often face challenges such as high unemployment, inflation and external shocks, which
can cause short-term fluctuations in the economy. In such situations, the countercyclical
measures recommended by the new Keynesian school, such as monetary and fiscal stimulus, can
prove effective in stabilizing the economy and promoting growth.

In addition to this, market failures, imperfect competition and information asymmetries may
occur in developing countries, which is consistent with the assumptions of the New Keynesian
model. These imperfections can justify government intervention to address market failures and
promote economic stability.

However, it is important to note that each country's specific circumstances should be considered
when determining the appropriate policy approach. Economic conditions, institutional factors,
and policy effectiveness may vary across countries, and a comprehensive analysis is necessary to
tailor the policy response to the specific needs of the country in question.

3) During World War II, both Germany and England planned to use paper money as a weapon
by printing and dropping massive amounts of each other's currency. This strategy could have
been effective due to the following reasons:

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  Hyperinflation: The influx of counterfeit banknotes should trigger hyperinflation in the
target country and lead to a loss of confidence in the economy and economic policies,
which could threaten the stability of the opposing country's economy and war effort, halt
trade and reduce purchases. Performance. Of its citizens.

 Changed tax liabilities and prices: Hyperinflation caused by falling banknotes would
change tax liabilities, create relative price volatility, and increase uncertainty, which
could further weaken the enemy's economy.
 Destruction of Confidence in the Enemy's Currency: The plan aimed to destroy
confidence in the enemy's currency, in the legality of its own currency and in the stability
of its government, causing it to lose value and increasing the importation of foreign
currency supplies prevent.
 Resource Diversion: Producing counterfeit banknotes required significant resources, and
using those resources to produce counterfeit currency had the potential to distract them
from a larger war, thus further weakening the enemy's military capabilities. Destabilize
Enemy Regimes: Economic chaos caused by the influx of counterfeit money can
potentially undermine an enemy government's stability, lead to internal unrest, and
weaken its ability to continue its war effort.
Overall, using paper money as a weapon could actually disrupt an enemy's economy,
undermine its stability, and divert resources from the war effort, potentially making it
powerful and unconventional
4) a) The labor force is the total number of people in working age population who are
currently active and employed or unemployment (actively seeking employment).

To find the labor force for each year, we can simply add the number of employed and
unemployed individuals.

For the year 1995:

Labor force = Number employed + Number unemployed

LF = 14,000,000 + 1,000,000 = 15,000,000

For the year 2000:

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LF= E + U = 14,500,000 + 1,500,000 = 16,000,000

For the year 2005:

LF= E + U = 15,000,000 + 2,500,000 = 17,500,000

b) A discouraged worker is a person is an individual who is eligible for employment and

who are able and will to work, but who is currently unemployed and has not attempted to find
employment. A discouraged worker is someone who has left the labor force because he or she
cannot find work.

Discouraged workers usually have given up on searching for a job because they found no
suitable employment options or failed to secure a job when they applied.

To find the number of discouraged workers for each year, we can subtract the number of
employed individuals from the number of adults able and wanting to work.

The following standards are used by the US Bureau of Labor Statistics to assess whether an
employee is a discouraged worker:

 is not employed at the moment

 Desires and is open to work
 has spent the previous 12 months looking for work
 has not looked for work in the previous four weeks.
 is not seeking employment because they don't think there are any positions available that
suit them or that they are qualified for
For the year 1995:

Number of discouraged workers = Adult population able and wanting to work - labor force =
15,700,000 - 15,000,000 = 700,000

For the year 2000:

Number of discouraged workers = Adult population able and wanting to work - labor force =
16,500,000 - 16,000,000 = 500,000

For the year 2005:

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Number of discouraged workers = Adult population able and wanting to work - Number
employed = 18,000,000 - 17,500,000 = 500,000

C) The labor force participation rate is the proportion or the percentage of the working-
age population that is either working or actively looking for work (labor force).

The labor-force participation rate is the percentage of the working-age population that is part of
the labor force. It is calculated as follows:

Labor-force participation rate = (Labor force / Adult population) * 100 = [(Employed +

unemployed)/Adult population] *100

For the year 1995:

Labor-force participation rate = [(14,000,000 + 1, 000,000)/18,000,000]*100

= (15,000,000 / 18,000,000) * 10 = 83.33%

For the year 2000:

Labor-force participation rate =[(14,500,000 + 1,500,000)/19,000,00] *100

= (16,000,000 / 19,000,000) * 100 = 84.21%

For the year 2005:

Labor-force participation rate = [(15,000,000 + 2,500,000)/20,500,000]*100

= (17,500,000 / 20,500,000) * 100 = 85.37%

d) The unemployment rate is the percentage of the labor force that is unemployed.

It is calculated as

Unemployment rate = (Number unemployed / Labor force) * 100 = U/(E + U)*100

For the year 1995:

UR= (1,000,000 / 15,000,000) * 100 = 6.67% = 6.7%

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For the year 2000:

UR = (1,500,000 / 16,000,000) * 100 = 9.4%

For the year 2005:

UR = (2,500,000 / 17,500,000) * 100 = 14.3%

References

N. Gregory Mankiw macroeconomics _7th edition _2007

https://www.investopedia.com/

https://quizlet.com/

https://www.yourarticlelibrary.com

https://www.chegg.com/