BADM7200

Policies to substantially reduce the natural rate of unemployment should be targeted at:

the long-term unemployed

Consider two large open economies - U.S. and Europe. If expansionary fiscal policy is adopted in Europe:

the real exchange rate and net exports rise in the U.S.

Discouraged workers are counted as

unemployed

Use the neoclassical theory of distribution to predict the impact on the real wage and the real rental price of capital of each of the following events: 1. A wave of immigration increases the labor force. 2. An earthquake destroys some of the capital stock. 3. A technological advance improves the production function. 4. High inflation doubles the prices of all factors and outputs in the economy.

1. According to the neoclassical theory of distribution, the real wage equals the marginal product of labor. Because of diminishing returns to labor, an increase in the labor force causes the marginal product of labor to fall. Hence, the real wage falls. Given a Cobb-Douglas production function, the increase in the labor force will increase the marginal product of capital and will increase the real rental price of capital. With more workers, the capital will be used more intensively and will be more productive. 2. The real rental price equals the marginal product of capital. If an earthquake destroys some of the capital stock (yet miraculously does not kill anyone and reduce the labor force), the marginal product of capital rises and, hence, the real rental price rises. Given a Cobb-Douglas production function, the decrease in the capital stock will decrease the marginal product of labor and will decrease the real wage. With less capital, each worker becomes less productive. 3. If a technological advance improves the production function, this is likely to increase the marginal products of both capital and labor. Hence, the real wage and the real rental price both increase. 4. High inflation that doubles the nominal wage and the price level will have no impact on the real wage. Similarly, high inflation that doubles the nominal rental price of capital and the price level will have no impact on the real rental price of capital.

Problem: If a war broke out abroad, it would affect the U.S. economy in many ways. Use the model of the large open economy to examine each of the following effects of such a war. What happens in the United States to saving, investment, the trade balance, the interest rate, and the exchange rate? To keep things simple, consider each of the following effects separately. 1. The U.S. government, fearing it may need to enter the war, increases its purchases of military equipment. 2.0Other countries raise their demand for high-tech weapons, a major export of the United States. The war makes U.S. firms uncertain about the future, and the firms delay some investment projects. The war makes U.S. consumers uncertain about the future, and the consumers save more in response. Americans become apprehensive about traveling abroad, so more of them spend their vacations in the United States. Next

1. An increase in government purchases reduces national saving. As the figure below shows, this raises the equilibrium interest rate. Since domestic investment and the net capital outflow are negatively related to the interest rate, they both decrease. The real exchange rate then appreciates to lower the trade balance to the level of the net capital outflow. 2. As shown in the figure below, increased demand for a country's exports shifts the net exports schedule to the right. Since nothing has changed in the market for loanable funds, saving, investment, and the interest rate remain the same. This in turn implies that the net capital outflow and trade balance remain the same. The shift in the net exports schedule causes the exchange rate to appreciate, making U.S. goods more expensive relative to foreign goods. The end result is that exports and imports increase by the same amount. 3. The reduction in investment projects shifts the investment demand schedule to the left. As the figure below shows, this lowers the interest rate, increases the net capital outflow and trade balance, and causes the real exchange rate to depreciate. Notice that, because national saving has not changed, the sum of investment and the net capital outflow remains unchanged. Thus, the increase in the net capital outflow is exactly offset by the decrease in investment. 4. The increased desire to save shifts the saving curve to the right. As shown in the figure below, this causes the real interest rate to decrease. Consequently, investment and the net capital outflow both increase. Finally, the real exchange rate depreciates, raising the trade balance to the level of the net capital outflow. 5. The reduced willingness of Americans to vacation abroad reduces imports, since foreign vacation expenditures count as imports. As shown in the figure below, this shifts the net exports schedule to the right. Since nothing has changed in the market for loanable funds, the interest rate remains the same, which in turn implies that the net capital outflow remains the same. Thus, the decreased demand for imports causes the exchange rate to appreciate but does not affect the trade balance.

Problem: Consider an economy with two sectors: manufacturing and services. Demand for labor in manufacturing and services are described by these equations: Lm = 200 - 6Wm Ls = 100 - 4Ws where L is labor (in number of workers), W is the wage (in dollars), and the subscripts denote the sectors. The economy has 100 workers who are willing and able to work in either sector. If workers are free to move between sectors, what relationship will there be between Wm and Ws? Suppose that the condition in part 1 holds, and wages adjust to equilibrate labor supply and labor demand. Calculate the wage and employment in each sector. Suppose a union establishes itself in manufacturing and pushes the manufacturing wage to $25. Calculate employment in manufacturing. In the aftermath of the unionization of manufacturing, all workers who cannot get the highly paid union jobs move to the service sector. Calculate the wage and employment in services. Now suppose that workers have a reservation wage of $15—that is, rather than take a job at a wage below $15, they would rather wait for a $25 union job to open up. Calculate the wage and employment in each sector. What is the economy's unemployment rate?

1. If workers are free to move between sectors, then the wages in the sectors must be equal. If the wages were not equal, then workers would have an incentive to move to the sector with the higher wage. This would cause the higher wage to fall and the lower wage to rise until they became equal. Since there are 100 workers in total, Ls = 100 - Lm. Substituting this in and setting the wages equal to W, the labor demand equations become Lm = 200 - 6W 100 - Lm = 100 - 4W. 2. The second equation implies that Lm = 4W. Substituting this into the first equation, we have 4W = 200 - 6W 10W = 200 W = 20. 3. Finally, we substitute the equilibrium wage into the labor demand equations to find that Lm = 80 and Ls = 20. If Wm =25, then Lm = 200 - 6 × 25 = 50. 4. There are now 50 workers employed in the service sector. Labor demand in services implies that 50 = 100 - 4Ws 4Ws = 50 Ws = 12.5. 5. The wage in manufacturing remains $25, and employment remains 50. At a reservation wage of $15, demand for labor in services is Ls = 100 - 4 × 15 = 40. There are then 10 unemployed individuals, so the unemployment rate is 10 percent.

According to the neoclassical theory of distribution, a worker's real wage reflects her productivity. Let's use this insight to examine the incomes of two groups of workers: farmers and barbers. Let Wf and Wb be the nominal wages of farmers and barbers, Pf and Pb be the prices of food and haircuts, and Af and Ab be the marginal productivity of farmers and barbers. 1. For each of the six variables defined above, state as precisely as you can the units in which they are measured. (Hint: Each answer takes the form "X per unit of Y.") 2. Over the past century, the productivity of farmers Af has risen substantially because of technological progress. According to the neoclassical theory, what should have happened to farmers' real wage, Wf/Pf? In what units is this real wage measured? 3. Over the same period, the productivity of barbers Ab has remained constant. What should have happened to barbers' real wage, Wb/Pb? In what units is this real wage measured? 4. Suppose that, in the long run, workers can move freely between being farmers and being barbers. What does this mobility imply for the nominal wages of farmers and barbers, Wf and Wb? 5. What do your previous answers imply for the price of haircuts relative to the price of food, Pb/Pf? 6. Suppose that barbers and farmers consume the same basket of goods and services. Who benefits more from technological progress in farming—farmers or barbers? Explain how your answer is consistent with the results on real wages in parts 2 and 3.

1. Nominal wages are measured as dollars per hour worked. Prices are measured as dollars per unit produced (either a haircut or a unit of farm output). Marginal productivity is measured as units of output produced per hour worked. 2. According to the neoclassical theory, technological progress that increases the marginal product of farmers causes their real wage to rise. The real wage for farmers is measured as units of farm output per hour worked. The real wage is W/Pf, and this is equal to ($/hour worked)/($/unit of food). 3. If the marginal productivity of barbers is unchanged, then their real wage is unchanged. The real wage for barbers is measured as haircuts per hour worked. The real wage is W/Pb, and this is equal to ($/hour worked)/($/haircut). 4. If workers can move freely between being farmers and being barbers, then they must be paid the same wage W in each sector. Otherwise, only one good will be produced. 5. If the nominal wage W is the same in both sectors, but the real wage in terms of farm goods is greater than the real wage in terms of haircuts, then the price of haircuts must have risen relative to the price of food. We know that W/P = MPL, so W = P x MPL. Since the nominal wages are the same, PfMPLf = PbMPLb. Thus, we have Pb/Pf = MPLf/MPLb. Since the marginal product of labor for barbers has not changed and the marginal product of labor for farmers has risen, the price of a haircut must have risen relative to the price of food. 6. Farmers and barbers benefit equally from technological progress in farming, given the assumption that labor is freely mobile between the two sectors and both types of workers consume the same basket of goods. Since labor is freely mobile between sectors, we know from part 4 that they receive the same nominal wage. Since they use this wage to purchase the same basket of goods and services, they are equally well off. This result is consistent with part 2 because, even though a farmer's real wage in terms of food rises, a farmer's real wage in terms of haircuts remains the same, given the increase in the relative price of haircuts found in part 5. This result is also consistent with part 3 because, even though a barber's real wage in terms of haircuts remains the same, a barber's real wage in terms of food rises, given the decrease in the relative price of food found in part 5.

Consider an economy described as follows: Y=C+I+G. Y=8,000. G=2,500. T=2,000. C=1,000+2/3 (Y−T). I=1,200−100 r. In this economy, compute private saving, public saving, and national saving. Find the equilibrium interest rate. Now suppose that G is reduced by 500. Compute private saving, public saving, and national saving. Find the new equilibrium interest rate.

1. Private saving is the amount of disposable income, Y − T, that is not consumed: Sprivate = Y − T − C = 8,000 − 2,000 − [1,000 + (2/3)(8,000 − 2,000)] = 1,000. Public saving is the amount of taxes the government has left over after it makes its purchases. Spublic = T − G = 2,000 − 2,500 = −500. National saving is the sum of private saving and public saving. Snational = Sprivate + Spublic = 1,000 + (−500) = 500. 2. The equilibrium interest rate is the value of r that clears the market for loanable funds. We already know that national saving is 500, so we just need to set it equal to investment: Snational = I 500 = 1,200 − 100r. Solving this equation for r, we find: r = 7. 3. When the government increases its spending, private saving remains the same as before (notice that G does not appear in the Sprivate equation above), while public saving decreases. Putting the new G into the equations above, we get: Sprivate = 1,000 Spublic = T − G = 2,000 − 2,000 = 0. Thus, Snational = Sprivate + Spublic = 1,000 + 0 = 1,000. 4. Once again, the equilibrium interest rate clears the market for loanable funds: Snational = I 1,000 = 1,200 − 100r. Solving this equation for r, we find r = 2.

Problem: Suppose that a country experiences a reduction in productivity—that is, an adverse shock to the production function. What happens to the labor demand curve? How would this change in productivity affect the labor market—that is, employment, unemployment, and real wages—if the labor market is always in equilibrium? How would this change in productivity affect the labor market if unions prevent real wages from falling? Next

1. The labor demand curve is given by the marginal product of labor. If a country experiences a reduction in productivity, then the labor demand curve shifts inward, as in the figure below. 2. Thus, for any given real wage, firms demand less labor. If the labor market is always in equilibrium, then, assuming a fixed labor supply, an adverse productivity shock causes a decrease in the real wage but has no effect on employment 3. If unions prevent the real wage from falling, then, as illustrated in Figure 7-3, employment falls to L1 and unemployment equals L - L1.

If the fraction of employed workers who lose their jobs each month (the rate of job separation) is 0.01 and the fraction of the unemployed who find a job each month is 0.09 (the rate of job findings), then the natural rate of unemployment is:

10%

How do we define money?

Amount of assets that can be readily used to make transactions Used and accepted to make transactions

In a speech that Senator Robert Kennedy gave when he was running for president in 1968, he said the following about GDP: [It] does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans. Was Robert Kennedy right? If so, why do we care about GDP?

As Senator Robert Kennedy pointed out, GDP is an imperfect measure of economic performance or well-being. In addition to the left-out items that Kennedy cited, GDP also ignores the imputed rent on durable goods such as cars, refrigerators, and lawnmowers; many services and products produced as part of household activity, such as cooking and cleaning; and the value of goods produced and sold in illegal activities, such as the drug trade. These imperfections in the measurement of GDP do not necessarily reduce its usefulness. As long as these measurement problems remain steady over time, then GDP is useful in comparing economic activity from year to year. Moreover, a large GDP allows us to afford better medical care for our children, newer books for their education, and more toys for their play. Finally, countries with higher levels of GDP tend to have higher levels of life expectancy, better access to clean water and sanitation, and higher levels of education. GDP is therefore a useful measure for comparing the level of growth and development across countries.

The GDP is determined by

Because V is constant, the money supply determines GDP P x Y

Who controls the money supply in the U.S. economy?

Federal Reserve - Central Bank Monetary policy is conducted by a country's central bank

What is the distinction between fiat money and commodity money?

Fiat money has no value in itself Commodity money has intrinsic value

When studying the short-run behavior of the economy, an assumption of ______ is more plausible, whereas when studying the long-run equilibrium behavior of an economy, an assumption of ______ is more plausible.

sticky prices; flexible prices

Suppose that an increase in consumer confidence raises consumers' expectations about their future income and thus increases the amount they want to consume today. This might be interpreted as an upward shift in the consumption function. How does this shift affect investment and the interest rate?

If consumers increase the amount that they consume today, then private saving and, therefore, national saving will both fall. We know this from the definition of national saving: National Saving = [Private Saving] + [Public Saving] = [Y − T − C(Y − T)] + [T − G]. An increase in consumption decreases private saving, so national saving falls. Figure 3-2 illustrates saving and investment as a function of the real interest rate. If national saving decreases, the supply curve for loanable funds shifts to the left, thereby raising the real interest rate and reducing investment.

Suppose that consumption depends on the interest rate. How, if at all, does this alter the conclusions reached in the chapter about the impact of an increase in government purchases on investment, consumption, national saving, and the interest rate?

In this chapter, we concluded that an increase in government expenditures reduces national saving and raises the interest rate. The increase in government expenditure therefore crowds out investment by the full amount of the increase. If consumption depends on the interest rate, then saving will also depend on it. The higher the interest rate, the greater the return to saving. Hence, it seems reasonable to think that an increase in the interest rate might increase saving and reduce consumption. Figure 3-6 shows saving as an increasing function of the interest rate. Consider what happens when government purchases increase. At any given level of the interest rate, national saving falls by the change in government purchases, as shown in Figure 3-7. The figure shows that if the saving function slopes upward, investment falls by less than the amount by which government purchases rise. This happens because consumption falls and saving increases in response to the higher interest rate. Hence, the more responsive consumption is to the interest rate, the less investment is crowded out by government purchases.

Quantity theory of money?

M x V = P x Y

What are the functions of money?

Medium of exchange Store of value Unit of Account Standard of deferred payment

The price level is

P = nominal GDP / real GDP

Consider an economy that produces and consumes hot dogs and hamburgers. In the following table are data for two different years: Hot Dog and Hamburger Prices Good Quantity in 2010 Price in 2010 Quantity in 2018 Price in 2018 Hot Dogs 200 $2 25 $4 Hamburgers 200 $3 500 $4 Part A: Using 2010 as the base year, compute the following statistics for each year: nominal GDP, real GDP, the implicit price deflator for GDP, and the CPI. Part B: By what percentage did prices rise between 2010 and 2018? Give the answer for each good and also for the two measures of the overall price level. Compare the answers given by the Laspeyres and Paasche price indexes. Explain the difference.

Part A: 1. Nominal GDP is the total value of goods and services measured at current prices. Therefore, Nominal GDP2010 = (P2010Hot dogs x Q2010Hot dogs ) + (P2010Burgers x Q2010Burgers ) = ($2 x 200) + ($3 x 200) = $400 + $600 = $1,000. Nominal GDP2018 = (P2018Hot dogs x Q2018Hot dogs ) + (P2018Burgers x Q2018Burgers ) = ($4 x 250) + ($4 x 500) = $1,000 + $2,000 = $3,000. 2. Real GDP is the total value of goods and services measured at base-year prices. In the base year (2010), real GDP is equal to nominal GDP, so real GDP in 2010 is $1,000. To calculate real GDP in 2018, multiply the quantities purchased in 2018 by the 2010 prices: Real GDP2018 = (P2010Hot dogs x Q2018Hot dogs ) + (P2010Burgers x Q2018 Burgers ) = ($2 x 250) + ($3 x 500) = $500 + $1,500 = $2,000. 3. The implicit price deflator for GDP is the ratio of nominal to real GDP. In the base year (2010), it is equal to 1. In 2018, we have: GDP Deflator 2018 = $3,000/$2,000 = 1.5. 4. The CPI uses a fixed basket of goods to measure changes in the price level over time. In the base year (2010), it is equal to 1. The CPI for 2018 measures the cost of the 2010 basket of goods in 2018 relative to the cost in 2010: CPI2018 = ((P2018Hot dogs x Q2010Hot dogs) + (P2018Burgers x Q2010Burgers))\((P2010Hot dogs x Q2010Hot dogs ) + (P2010Burgers x Q2010Burgers)) = (($4 x 200) + ($4 x 200))\(($2 x 200) + ($3 x 200)) = $1,600\$1,000 = 1.6 Part B: The GDP deflator is a Paasche index because it has a changing basket of goods, while the CPI is a Laspeyres index because it has a fixed basket of goods. The GDP deflator for 2018 is 1.5, which indicates that prices rose by 50 percent from their 2010 levels. The CPI for 2018 is 1.6, which indicates that prices rose by 60 percent from their 2010 levels.If the prices of all goods rose by, for example, 50 percent, then one could say unambiguously that the price level rose by 50 percent. In our example, however, relative prices changed. The price of hot dogs rose by 100 percent, while the price of hamburgers rose by 33.33 percent, making hamburgers relatively less expensive. Consumers responded by increasing the quantity of hamburgers purchased relative to the quantity of hot dogs purchased. Since the CPI has a fixed basket of goods, it does not take into account this substitution effect and therefore gives a higher inflation rate than the GDP deflator.

An economy has 100 people divided among the following groups: 25 have full-time jobs, 20 have one part-time job, 5 have two part-time jobs, 10 would like to work and are looking for jobs, 10 would like to work but are so discouraged they have given up looking, 10 are running their own businesses, 10 are retired, and 10 are small children. Part A: Calculate the labor force and the labor-force participation rate. Part B: Calculate the number of unemployed and the unemployment rate. Part C: Calculate total employment in two ways: as measured by the household survey and as measured by the establishment survey.

Part A: The labor force includes full-time workers, part-time workers, those who run their own businesses, and those who do not have a job but are looking for one. The labor force consists of 70 people. The labor-force participation rate, which is the share of the adult population in the labor force, is (70/90) x 100 = 77.8 percent. Part B: Unemployed workers are those who would like to work and are looking for jobs, so there are 10. The unemployment rate, which is the share of the labor force that is unemployed, is (10/70) x 100 = 14.3 percent. Part C: The household survey estimates total employment by asking a sample of households about their employment status. The household survey would report 60 people employed. The establishment survey estimates total employment by asking a sample of businesses to report how many workers they are employing. In this case, the establishment survey would report 55 people employed because the 5 people with 2 jobs would be counted twice and the 10 people who run their own businesses would not be counted.

Variables that a model tries to explain are called

endogenous

Consider whether each of the following events is likely to increase or decrease real GDP. In each case, do you think the well-being of the average person in society most likely changes in the same direction as real GDP? Why or why not? A hurricane in Florida forces Disney World to shut down for a month. The discovery of a new, easy-to-grow strain of wheat increases farm harvests. Increased hostility between unions and management sparks a rash of strikes. Firms throughout the economy experience falling demand, causing them to lay off workers. Congress passes new environmental laws that prohibit firms from using production methods that emit large quantities of pollution. More high school students drop out of school to take jobs mowing lawns. Fathers around the country reduce their workweeks to spend more time with their children.

Real GDP falls because Disney World does not produce any services while it is closed. This corresponds to a decrease in economic well-being because the income of workers and shareholders of Disney World falls (the income side of the national accounts), and people's consumption of Disney World falls (the expenditure side of the national accounts). Real GDP rises because the original capital and labor in farm production can now produce more wheat. This corresponds to an increase in the economic well-being of society since people can now consume more wheat or some of the capital and labor in farm production can be reallocated to producing other goods that society values. Real GDP falls because, with fewer workers on the job, firms produce less. The resulting lower income and consumption leads to a fall in economic well-being. Real GDP falls because the firms that lay off workers produce less. This decreases economic well-being because workers' incomes fall, and there are fewer goods for people to consume. Real GDP is likely to fall, as firms shift toward production methods that produce fewer goods but emit less pollution. Economic well-being, however, may rise. The economy now produces less measured output but more clean air. Clean air is not a market good and thus does not show up in measured GDP, but it is nevertheless a good that people value. Real GDP rises because the high school students go from an activity in which they are not producing market goods and services to one in which they are. Economic well-being, however, may decrease. In ideal national accounts, attending school would show up as investment because it presumably increases the future productivity of the worker. Actual national accounts do not measure this type of investment. Note also that future GDP may be lower than it would be if the students stayed in school since the future workforce would be less educated. Measured real GDP falls because fathers spend less time producing market goods and services. The fathers are, however, providing more unmeasured child-rearing services. The well-being of the average person may rise if the fathers and children sufficiently benefit from the extra time they spend together.

Problem: On September 21, 1995, "House Speaker Newt Gingrich threatened today to send the United States into default on its debt for the first time in the nation's history, to force the Clinton Administration to balance the budget on Republican terms" (New York Times, September 22, 1995, p. A1). That same day, the interest rate on 30-year U.S. government bonds rose from 6.46 to 6.55 percent, and the dollar fell in value from 102.7 to 99.0 yen. Use the model of the large open economy to explain this event.

Solution: Because of the higher risk of default, there is lower demand for U.S. Treasury securities. As the figure below shows, this causes the net capital outflow schedule to shift to the right. In the loanable funds market, the higher U.S. demand for loanable funds drives up the real interest rate, which in turn lowers investment. Since the equilibrium amount of I + CF is unchanged, the net capital flow must increase, which causes the real exchange rate to depreciate and the trade balance to rise

Problem: Suppose that Congress passes legislation making it more difficult for firms to fire workers. (An example is a law requiring severance pay for fired workers.) If this legislation reduces the rate of job separation without affecting the rate of job finding, how would the natural rate of unemployment change? Do you think it is plausible that the legislation would not affect the rate of job finding? Why or why not?

Solution: Consider the formula for the natural rate of unemployment: U/L = s/(s + f ). If the new law lowers the rate of job separation s but has no effect on the rate of job finding f, then the natural rate of unemployment falls. The new law is also likely to lower f for two main reasons. First, raising the cost of firing might make firms more careful about hiring workers since it will be more costly to fire a worker who turns out to be a poor match. Second, if job searchers think that the new legislation will lead them to spend a longer period of time at a particular job, they might weigh more carefully whether to accept a job offer. If the reduction in f is large enough, then the new policy could even increase the natural rate of unemployment.

Problem: The residents of a certain dormitory have collected the following data: people who live in the dorm can be classified as either involved in a relationship or uninvolved. Among involved people, 10 percent experience a breakup of their relationship every month. Among uninvolved people, 5 percent enter into a relationship every month. What is the steady-state fraction of residents who are uninvolved?

Solution: We can reinterpret the formula for the natural rate of unemployment: U/L = s/(s + f ). Let U/L be the steady-state fraction of residents who are uninvolved, let s = 0.1 be the rate at which involved residents break up, and let f = 0.05 be the rate at which uninvolved residents enter into relationships. The steady-state fraction of residents who are uninvolved is then U/L = s/(s + f ) = 0.1/(0.1 + 0.05) = 2/3.

How do we measure the quantity of money in the economy?

The money supply equation M = m x B, where m = C / D + 1 -------------- C / D + R / D • If monetary base changes by ΔB, then ΔM = m × ΔB

What is the role of banks in the monetary system?

To control the money supply, the Fed uses open-market, operations, the purchase and sale of government bonds.

Suppose that the government increases taxes and government purchases by equal amounts. What happens to the interest rate and investment in response to this balanced-budget change? Explain how your answer depends on the marginal propensity to consume.

To determine the effect on investment of an equal increase in both taxes and government spending, consider the national income accounts identity for national saving: National Saving = [Private Saving] + [Public Saving] = [Y − T − C(Y − T)] + [T − G]. We know that Y is fixed by the factors of production. We also know that the change in consumption equals the marginal propensity to consume (MPC) times the change in disposable income. This tells us that Δ(National Saving) = {−ΔT − [MPC ´ (−ΔT)]} + [ΔT − ΔG] = [−ΔT + (MPC ´ ΔT)] + 0 = (MPC − 1) ΔT. This expression tells us that the impact on national saving of an equal increase in T and G depends on the size of the marginal propensity to consume. The closer the MPC is to 1, the smaller the fall in saving. For example, if the MPC equals 1, then the fall in consumption equals the rise in government purchases, so national saving [Y − C(Y − T) − G] is unchanged. The closer the MPC is to 0 (and therefore the larger the amount saved rather than spent for a one-dollar change in disposable income), the greater the impact on saving. Because we assume that the MPC is less than 1, we expect that national saving falls in response to an equal increase in taxes and government spending. The reduction in saving means that the supply of loanable funds curve will shift to the left in Figure 3-3. The real interest rate rises, and investment falls.

Which of the following is the best example of structural unemployment?

Vickie lost her job as a graphic artist at a movie studio because she did not have training in computer-generated animation.

Use the model of supply and demand to explain how a fall in the price of frozen yogurt would affect the price of ice cream and the quantity of ice cream sold. In your explanation, identify the exogenous and endogenous variables.

We can use a simple variant of the supply-and-demand model for pizza to answer this question. Assume that the quantity of ice cream demanded depends not only on the price of ice cream and income but also on the price of frozen yogurt: Qd = D(PIC, PFY, Y). We expect that demand for ice cream will rise when the price of frozen yogurt rises because ice cream and frozen yogurt are substitutes. That is, when the price of frozen yogurt goes up, households will consume less of it and instead fulfill more of their frozen dessert desires with ice cream. The next part of the model is the supply function for ice cream, Qs = S(PIC). Finally, in equilibrium, supply must equal demand, so that Qs = Qd. The exogenous variables are Y and PFY, and the endogenous variables are Q and PIC. Figure 1-1 uses this model to show that a fall in the price of frozen yogurt results in an inward shift of the demand curve for ice cream. The new equilibrium has a lower price and quantity of ice cream.

Unions contribute to structural unemployment when collective bargaining results in wages:

above the equilibrium level

Net capital outflow in a large country:

declines as the domestic interest rate rises.

If wage rigidity holds the real wage above the equilibrium level, an increase in the supply of labor will ______ the number unemployed.

decrease

Political instability in the U.S.

decreases the real interest rate and depreciates the real exchange rate

Expansionary fiscal policy in a large open economy ______ the real exchange rate and ______ net exports.

decreases; increases

In a large open economy, the interest rate adjusts so that domestic saving equals:

domestic investment plus net capital outflow

The unemployment resulting when real wages are held above equilibrium is called ______ unemployment, while the unemployment that occurs as workers search for a job that best suits their skills is called ______ unemployment.

structural; frictional

In a large open economy, if political instability abroad lowers the net capital outflow function, then the real interest rate:

falls, while the real exchange rate rises and net exports rise

In the case of unions, the conflict of interest between different groups of workers results in insiders wanting ______, while outsiders want ______.

high wages; more hirings

For an open economy with perfect capital mobility, when net capital outflow is measured along the horizontal axis and the real interest rate is measured along the vertical axis, net capital outflow is drawn as a:

horizontal line at the world real interest rate.

Expansionary fiscal policy in a large open economy ______ the real interest rate and ______ the real exchange rate.

increases; increases

For a closed economy, when net capital outflow is measured along the horizontal axis and the real interest rate is measured along the vertical axis, net capital outflow is drawn as a:

line that slopes down and to the right.

Consider two large open economies - U.S. and Europe. If expansionary fiscal policy is adopted in Europe, what happens in the U.S?

net capital outflow rises, the real interest rate rises and investment spending falls.

In a large open economy, if an import quota is adopted, then:

net exports remain unchanged, as imports and exports decrease by equal amounts, while the real exchange rate rises. Clear my choice

In a large open economy, if the tariff rate is reduced, then:

net exports remain unchanged, as imports and exports increase by equal amounts, while the real exchange rate falls

Assume that a country experiences a reduction in productivity that shifts the labor demand curve downward and to the left. If the real wage were rigid, this would lead to:

no change in the real wage and a rise in unemployment

Any policy aimed at lowering the natural rate of unemployment must either ______ the rate of job separation or ______ the rate of job finding

reduce; increase

Unemployment insurance increases the amount of frictional unemployment by:

softening the economic hardship of unemployment

A graph of the rate of inflation in the United States over the twentieth century shows

some periods of deflation mixed with mostly positive rates of inflation before 1955 but only positive rates of inflation after 1955