Nathan Susman!

5-7-14!
Macroeconomics!

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Problem Set Macroeconomics #4!

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1. Wray denies that savings finance investment because usually, entrepreneurs do not
start out with all of the capital they need in order to finance their businesses. Were
entrepreneurs to work for other people, attempting to save money until they possessed in their
bank accounts the hundreds of thousands of euros necessary to start a business, innovation
would be severely stifled. Banks serve as intermediaries between the supplier and their dreams
of selling to their customers, giving entrepreneurs access to credit. By putting up collateral,
entrepreneurs can access a loan of assets and invest without having access to previous
savings. The creation of credit allows firms to produce their commodities and generate
increased output and increased profits in response to an increase in their money supply.
With the profits generated from the goods a firm sells, they are able to pay back their loan to the
bank, with extra cash (savings) left over that they can then transform into investment.

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2. a. During good times, the private sector will often borrow lots of money from the
banks. This is because lots of people have extra cash in their pockets and are willing to
consume more. Banks know that they issue debts on themselves to finance loans that
eventually lead to the creation of new wealth. The ability of firms to generate profits out of
current expenditure and return the loans to the banks with interest is assessed by every bank
before loans are created. As the private sector borrows, investment increases and drives output
growth in the economy, as the banks profit from interest off their loans and are able to extend
capital to enterprises they may have previously dismissed as too risky. According to the theory
of the monetary circuit, when customers buy goods from the firm, they exchange dollars for
what they are purchasing, with the bank acting as the intermediary/third point of the triangle
allowing for this transaction to be marked on a ledger, as well as creating credit through the loan
given. During bad times, when peoples marginal propensity to consume is lower, output lowers
as well as firms adjust to weaker demand. Firms then draw upon their savings to repay the
bank, destroying the credit they had with them but creating reserves by which the bank earns
profit. !

b. Because the modern economy is so complex, government intervention has been found to be
necessary in order to decrease the vulnerability of aggregate profit flows as well as to serve as
a powerful refinancing agent for financial institutions and private firms. A strong governments
hand in the economy ensures that regulations exist to keep the economy within reasonable
bounds that banks do not overextend themselves, loaning to clients who clearly lack collateral
or the ability to repay, and that firms are able to pay back their existing debts without shutting
down.!

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3. The paradox of thrift is based around the conventional wisdom that it is better to save
money for a proverbial rainy day rather than spend on everything one sees. When individuals
choose to save their money, they are able to accumulate capital that they may spend on larger
purchases. On a microeconomic scale, this is sound practice, but if everyone were to suddenly
become a spendthrift and increase savings, the lack of real money in the economy would fall as
demand falls. This would lead firms to engage in conservative behavior such as factory
closings, firings, and decreasing output and research into new products. The economy depends

on individuals choosing to circulate their money and allowing it to change hands, ensuring that
firms are able to keep production steady and stay in business.!

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4. Labor markets dont clear because during an economic downturn, as the demand for
jobs rises, the cost of wages remains sticky and does not fluctuate. If the labor market were to
clear that is, if the salary employers were willing to pay for labor reached a small enough size
workers would choose to become unemployed rather than spend their days working for a
menial and inconsequential wage. In some economies, unemployment benefits accrued by
those who are not working are greater in value than a wage that people cannot live on, so
people remain wards of the state. When people are paid below the wage that they believe they
should earn, they do not take pride in their work output can slow and goods produced can be
sub-par.