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LAZ Listening Exam 01 – Level B2 Prof. Peter Cullen Spring/2012 Text The economy is a dynamic system. All this means is that the economy changes over time. This is obvious: prices bounce up and down, wages change, and companies enter and exit markets. This dynamism is something that Traditional Economics has recognized, but has generally views as generated by external (exogenous) sources such as technology changes, political events, and changes in consumer taste. The interesting question for complexity economists is how such dynamic behaviour might be generated internally (endogenously), as a result of the structure of the economy itself. When scientists talk about a system being dynamic, what they mean is that the state of the system at the current moment is a function of the state of a the system at the previous moment, and some change in between the two moments. A simple example of a dynamic system is your bank account. The state of the account, or balance, changes over time. Your balance tomorrow is dependent on your balance today, plus any changes during the intervening day such as deposits, withdrawals, or interest payments. Changes in a dynamic process can either be discrete, like a bank account, in which the changes occur at specific points in time, or they can be continuous and smooth, like the orbiting of planets. A convenient way to describe a dynamic system is in terms of stocks and flows. A stock is an accumulation of something, such as the balance in a bank account or water in a bathtub. The rate at which a stock changes over time is known as a flow – for example the rate of money flowing into or out of a bank account or water flowing into and out of the bathtub. The economy is full of different stocks that change over time, for example the total supply of money or the number of people employed. Each of these stocks has corresponding flows, or rates of change over time. For example, the central bank might increase or decrease the money supply, or companies might hire or fire employees. Note that flows are always per some unit of time. Stocks and flows do not always have to be tangible things such as money and people. They can also be less tangible, such as consumer confidence. When one starts thinking of the economy as a collection of stocks and their related flows, it quickly becomes apparent that the various stocks and flows are connected to each other in complex ways. For example, if the stock of employment fell to a low level, a policy maker might decide to cut interest rates in order to encourage borrowing, which would expand the stock of money available for investment, which would be used by businesses to invest in new productive capacity, creating more demand for employees. This would raise the stock of employment and thus feed back to affect future interest rate policy. Such chains of relationships between stocks and flows in a dynamic system are known as feedback loops. 1 LAZ Listening Exam 01 – Level B2 Spring/2012 Prof. Peter Cullen ___________________________________________ Name, Date, and Registration Number Questions: Answer all 5 of the following questions. SIMPLE AND CORRECT IS BETTER THAN COMPLICATED AND WRONG. USE SHORT PHRASES AND SENTENCES. This exam requires interpretation and analysis. It is designed to test your ability to apply what you hear to possible discussion areas. 1. How do Traditional Economists view exogenous factors differently from Complexity Economists? 2. Why is a bank account a good example of a dynamic system? 3. What does the author mean by “discrete change”? 4. What is the relationship between stocks and flows? 5. Why is the example of employment levels and interest rates considered a feedback loop? 2 LAZ Listening Exam 1 – Level B2 Prof. Peter Cullen Spring/2012 Answer Sheet 1. How do Traditional Economists view exogenous factors differently from Complexity Economists? TEs think that changes in the economy are caused by external factors such as politics or technology. CE are interested in how internal dynamics change in the economy. 2. Why is a bank account a good example of a dynamic system? Because the balance on one day depends on the balance on the previous day plus the movements into and out of the account. 3. What does the author mean by “discrete change”? Change that occurs at a specific point in time. 4. What is the relationship between stocks and flows? Stocks are the basic amount of accumulated units of wealth, and flows are the way the quantity of these units changes over time. 5. Why is the example of employment levels and interest rates considered a feedback loop? Because the level of employment can be influenced by raising or lowering interest rates, which causes a new level of employment and new costs for businesses – requiring a new interest rate to put money into or take money out of the economy in light of the new employment level. . 3