ECON 2315 Quiz

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​3.) Which of the following describes one way in which classical and Keynesian economists continue to differ from each​ other?

Keynesians tend to think that prices are slow to adjust.

a. Expansionary monetary policy increases the demand for primary sector output.

Primary​ market: increase in employment and​ output, no change in the real wage. Secondary​ market: decrease in employment and​ output, increase in the real wage.

d. There is a temporary productivity improvement in the primary sector.

Primary​ market: increase in employment and​ output, no change in the real wage. Secondary​ market: decrease in employment and​ output, increase in the real wage.

b. Immigration increases the labor force.

Primary​ market: no change in employment and​ output, no change in the real wage. Secondary​ market: increase in employment and​ output, decrease in the real wage.

According to the Keynesian ​IS-LM​ model, what is the​ short-run effect of of the following​ shock: on​ output, the real interest​ rate, employment, and the price level. Financial deregulation allows banks to pay a higher interest on checking accounts

Short-run: Output: Decrease Real Interest​ Rate: Increase ​Employment: Decrease Price​ Level: Remains unchanged

All of the following can shift the LM curve down and to the right except

a reduction in money supply.

Which of the following is an example of reverse​ causation?

businesses increase their money demand for transactions before they increase output

The IS curve​ represents:

combinations of output and the real interest rate such that desired national saving is equal to desired investment.

The misperceptions theory concludes​ that:

in the short​ run, anticipated monetary changes are neutral but unanticipated monetary changes are not neutral.

Assume that the rightward shift in labor supply is smaller than the leftward shift in labor demand. In the new​ equilibrium, the real wage is​ ____ and the equilibrium amount of employment is​ _____, compared with the equilibrium before the productivity shock occurred. The FE curve shifts​ _____ and the IS curve shifts​ _____. In general​ equilibrium, the real interest rate is​ _____ and output is​ _____, compared with the equilibrium before the productivity shock. If the productivity shock were temporary rather than​ permanent, the main difference is that the​ _____ curve would not shift. If the productivity shock were temporary rather than​ permanent, the main difference is that the real interest rate would​ _____ instead of being ambiguous and the price level would​ _____ instead of being ambiguous.

lower; lower left; down and to the left ambiguous; lower IS curve increase; increase

For constant​ output, if the real money supply exceeds the real quantity of money demanded at some initial real interest​ rate,

people with excess money balances purchase nonmonetary​ assets, thus increasing the market price of the nonmonetary assets and reducing the real interest rate until an equilibrium is reached.

Which of the following does not cause a change in the Solow​ residual?

A change in expectations.

Suppose that the Fed has a policy of increasing the money supply when it observes that the economy is in recession.​ However, suppose that about six months are needed for an increase in the money supply to affect aggregate​ demand, which is about the same amount of time needed for firms to review and reset their prices. What effects will the​ Fed?s policy have on output and price​ stability?

A lag in the impact of policy of six​ months, which is about the time it takes firms to adjust​ prices, could cause policy to be destabilizing

In this​ model, how is​ full-employment output affected by changes in productivity​ (supply shocks)?

A productivity shock affects the marginal product of​ labor, so employment changes

How is a temporary increase in government purchases likely to affect the composition of output in the ​long-run​?

Consumption​ Expenditure: Decrease Investment Expenditure: Decrease

​2.) Which step in calibration is done with the assistance of a​ computer's random number​ generator?

Creation of economic shocks.

​2.) Which of the following is not a feature of Keynesian thought that classical economists have come to incorporate into their models​ recently?

Efficiency wages.

b. Using the classical ​IS-LM model​ (with no​ misperceptions), determine the ​general-equilibrium effects of an increase in the expected future marginal product of capital on the following​ variables:

Employment remains unchanged. Output remains unchanged. The price level increases. The real interest rate increases. Consumption decreases. Investment increases.

In the context of the relationship between the money supply and real economic​ activity, what is meant by reverse​ causation?

In the context of the relationship between the money supply and real economic​ activity, what is meant by reverse​ causation?

Is money neutral in the short run or the long​ run, according to the ​AD-AS​ model?

In the short​ run, money is not​ neutral, but in the long run it is neutral

Consider the​ general-equilibrium effects of a temporary adverse supply shock. For each of the following​ variables, select whether you would expect it to​ increase, decrease, or remain constant in general equilibrium as a result of the temporary supply shock. For each of the following​ variables, select whether you would expect it to​ increase, decrease, or remain constant as a result of the temporary adverse supply shock.

Output will decrease. The real interest rate will increase. The price level will increase. Consumption will decrease. Investment will decrease. Government spending will stay the same. The nominal money supply will stay the same.

Which of the following best describes the FE​ line?

The FE line is vertical at the​ full-employment level of output.

b. Suppose that the Fed wants to stabilize the current price level. How will the Fed respond to the increase in expected future​ output?

The Fed will increase the money supply in response to the increase in money​ demand, which shows reverse causation.

In the ​AD-AS​ model, the​ long-run effect of a decrease in the money supply is

a proportionate fall in the price​ level, but no changes to real variables such as output.

In the ​AD-AS​ model, the​ short-run effect of a decrease in the money supply is

a shift down and to the left of the AD ​curve, causing output to fall at an unchanged price level.

The main components that any theory of the business cycle must contain or describe are

a specification of the types of shocks affecting the economy and a model of the macroeconomy that explains how the economy responds to such shocks.

For each of the​ following, assume​ that, when the economy is in​ disequilibrium, only the labor market is out of​ equilibrium; assume also that for a short period firms are willing to produce enough output to meet the aggregate demand for output. a. Suppose that the price level is fixed in the short run so that the economy​ doesn't reach general equilibrium immediately after a change in the economy. Determine the​ short-run effects on the real interest rate and output when the expected rate of inflation rises b. Suppose that the price level is fixed in the short run so that the economy​ doesn't reach general equilibrium immediately after a change in the economy. Determine the​ short-run effects on the real interest rate and output when an decrease in consumer optimism increases desired consumption at each level of income and the real interest rate. c. Suppose that the price level is fixed in the short run so that the economy​ doesn't reach general equilibrium immediately after a change in the economy. Determine the​ short-run effects on the real interest rate and output when there is an decrease ​(temporarily) in government purchases. d. Suppose that the price level is fixed in the short run so that the economy​ doesn't reach general equilibrium immediately after a change in the economy. Determine the​ short-run effects on the real interest rate and output when there is an decrease in​ lump-sum taxes, with no change in government purchases. Consider both the case in which Ricardian equivalence holds and the case in which it​ doesn't. e. Suppose that the price level is fixed in the short run so that the economy​ doesn't reach general equilibrium immediately after a change in the economy. Determine the​ short-run effects on the real interest rate and output when a scientific breakthrough decrease the expected future MPK.

a. Real Interest Rate Falls; Output Increases b. Real Interest Rate Falls; Output decrease c. Real Interest Rate Falls; Output decreases d. When Ricardian Equivalence holds. Real Interest Rate remains unchanged; Output remains unchanged. When Ricardian Equivalence does not hold. Real Interest Rate rises; Output increases. e. Real Interest Rate falls; Output decreases

All of the following will shift the FE line​ except:

an increase in price level

​3.) One way to test whether people have rational expectations is to

ask people to make predictions about future economic events.

In the classical model with​ misperceptions, in the short​ run, an unanticipated increase in the money​ supply:

causes the aggregate demand curve to shift up and to the​ right, leaving the​ short-run aggregate supply curve unchanged.

​1.) The goal of calibration is to

create a numerical example from a more general theoretical model.

​1.) The Application is about Henry Ford and the Ford Motor Company and

how an increase in wages can be good for profitability.

The main difference between the classical ​IS-LM model and the Keynesian ​IS-LM model is that

in the classical​ model, prices are assumed to adjust quickly to restore​ equilibrium, while in the Keynesian​ model, prices are slow to adjust to restore equilibrium. The distinction between the classical ​IS-LM model and the Keynesian ​IS-LM model is important because the classicals are less likely​ than/as Keynesians to recommend government intervention to restore equilibrium.

​3.) Edward​ Prescott's calibration​ work, as described in the​ Application,

indicated that his model did a good job modeling volatilities in output.

b. The growth rate of the Solow residual

is equal to the growth in productivity as measured by the parameter A.

How does this change the algebraic expressions for each of the variables​ below? How does the change in the​ money-demand equation affect the algebraic expression for the​ general-equilibrium value of​ employment? How does the change in the​ money-demand equation affect the algebraic expression for the​ general-equilibrium value of the real​ wage? How does the change in the​ money-demand equation affect the algebraic expression for the​ general-equilibrium value of​ output? How does the change in the​ money-demand equation affect the algebraic expression for the​ general-equilibrium value of the real interest​ rate? Given the equation for the price​ level, the equilibrium value of the price level is now​ _____ it was​ before, assuming that

no effect no effect no effect no effect lower than

In this​ problem, you will use the ​IS-LM model to analyze the​ general-equilibrium effects of a permanent increase in the price of oil​ (a permanent adverse supply​ shock) on macroeconomic variables. Assume​ that, besides reducing the current productivity of capital and​ labor, the permanent supply shock lowers both the expected future MPK and​ households' expected future incomes. The increase in the price of oil​ _____ the marginal product of​ labor, causing the labor demand curve to shift​ ____. Since​ households' expected future incomes​ ____, labor supply​ _____, shifting the labor supply curve​ _____.

reduces; to the left decline; increases; to the right

In each of the following​ cases, what is the effect on the AD​ curve? An increase in the effective tax rate on capital An increase in the money supply An increase in the price level

shifts the AD curve down and to the left. shifts the AD curve up and to the right. does not shift the AD curve.

In each of the following​ cases, what is the effect on the FE​ line? An adverse supply shock An increase in the labor supply An increase in the money supply

shifts the FE line leftward. shifts the FE line rightward. does not change the FE line.

In each of the following​ cases, what is the effect on the IS​ curve? An increase in the effective tax rate on capital An increase in the money supply A temporary increase in goverment spending

shifts the IS curve down and to the left. does not change the IS curve. shifts the IS curve up and to the right.

In each of the following​ cases, what is the effect on the LM​ curve? An increase in the expected inflation rate An increase in government spending An increase in the price level

shifts the LM curve down and to the right. does not shift the LM curve. shifts the LM curve up and to the left.

In each of the following​ cases, what is the effect on the​ short-run aggregate supply ​(SRAS​) ​curve? An increase in firm costs An increase in the money supply An increase in consumption

shifts the SRAS curve upward. does not shift the SRAS curve. does not shift the SRAS curve.

The Solow​ residual, the most common measure of productivity shocks is

strongly procyclical

c. Under the misperceptions​ theory, an increase in expected future marginal product of capital causes all of the following in general equilibrium except that

the SRAS and LRAS curves do not​ shift, the AD curve shifts up and to the​ right, the price level​ increases, but output remains unchanged at the​ full-employment level.

Describe the​ short-run aggregate supply ​(SRAS​) curve and the​ long-run aggregate supply ​(LRAS​) curve. Why is the​ short-run aggregate supply curve​ horizontal? Why is the​ long-run aggregate supply curve​ vertical?

the SRAS curve is horizontal and the LRAS curve is vertical because prices remain fixed in the short run because the aggregate amount of output supplied is the​ full-employment level, regardless of the price level

Menu costs​ are, by definition

the costs of changing prices

What business cycle fact is reverse causation intended to​ explain?

the fact that money is procyclical and a leading variable

The position of the FE line is determined​ by:

the labor market and the production function.

General equilibrium occurs at which point in the IS−LM diagram?

the point at which the FE line and the IS and LM curves intersect

If the economy​ isn't in general​ equilibrium, what determines output and the real interest​ rate?

the point at which the IS and LM curves intersect

What happens in the long run if policymakers make no change in macroeconomic​ policy?

the price level will be lower and employment will return to its​ full-employment level

What happens in the long run if policymakers increase government purchases​ appropriately?

the price level will be unchanged and employment will return to its​ full-employment level

Price stickiness​ is:

the tendency of prices to adjust slowly to changes in the economy

​1.) When economists say that people have rational​ expectations, they mean that

they utilize available information in making decisions.

If rational expectations do indeed​ exist, the error term in such studies should be

unpredictable and random.

Scalping and arbitrage are

activities that allow prices to quickly respond to changes in market conditions​ -- more often on the demand side of the market. Encouraging​ 'scalping' and other forms of arbitrage in a market economy will likely lead to a lesser degree of price stickiness in that economy.

What economic forces act to bring the economy back to general​ equilibrium?

adjustment of the price level moves the LM curve

The efficiency wage​ is:

an amount that maximizes effort or efficiency per dollar of real wages. An assumption about worker behavior behind the efficiency wage theory is that effort is directly related to the worker compensation.

According to the misperceptions​ theory, producers are unable to determine whether an increase in prices is an increase in relative prices or an increase in the general price level. This inability​ generates:

an upward sloping​ short-run aggregate supply curve.

After prices​ adjust, money is neutral in the ​IS-LM model​ because:

any change in money supply that shifts the LM curve is finally matched by a proportional change in the price level that shifts the LM curve to its original position.

Money is said to be neutral ​if:

if a change in the money supply changes the price level and other nominal variables but has no effect on real variables.

According to the Keynesian​ analysis, in what two ways does an adverse supply shock reduce​ output?

the supply shock reduces the marginal product of labor and shifts the LM curve up and to the left

Describe three alternative responses available to policymakers when the economy is in recession.

​(1) make no change in macroeconomic​ policy, (2) increase the money​ supply, or​ (3) increase government purchases.

Which of the following best describes a general​ equilibrium?

All markets are simultaneously in equilibrium.

d. Assume that consumers respond to permanent increase in taxes by reducing their consumption in each period by the full amount of the tax increase. Also assume that investment remains unchanged. Using the classical ​IS-LM model determine the effects of a permanent increase in government purchases which is financed by an increase in​ taxes, on the following​ curves:

The FE line shifts to the right. The IS curve does not shift. The LM curve shifts down and to the right

What does the Keynesian model predict about the cyclical behavior of average labor​ productivity?

The Keynesian theory assumes that demand shocks cause most cyclical fluctuations. This means that during expansions when employment​ rises, average labor productivity​ declines, so it is countercyclical.

According to the classical​ model, after an economic​ disturbance, which of the following is​ true?

The economy will rapidly return to general equilibrium as prices adjust quickly.

How does your answer depend on​ (a) the direct benefits of the government spending program and​ (b) the speed with which prices adjust in the absence of fiscal​ stimulus?

The more beneficial are government​ purchases, and the longer the free market takes to restore​ equilibrium, the more likely such a program is to increase economic welfare.

b. Because the tax increase is​ permanent, assume that at any constant levels of output and the real interest​ rate, consumers respond by reducing their consumption each period by the full amount of the tax increase.​ Also, assume that investment is unaffected by any change in government purchases. Under these​ assumptions, determine how a permanent increase in government purchases affect the following​ curves:

The national saving curve does not shift. The IS curve does not shift

c. Suppose that after such a permanent increase in​ taxes, consumers respond by reducing their consumption each period by less than the full amount of the tax​ increase, in contrast to the behavior assumed in part b.​ Also, suppose that investment is unaffected by any change in government purchases. Under these​ assumptions, determine how a permanent increase in government purchases financed by a permanent increase in taxes affect the following​ curves:

The national saving curve shifts to the left. The IS curve shifts up and to the right

Use the classical ​IS-LM model to find the effects of the fiscal change on​ output, employment, the​ (before-tax) real​ wage, the real interest​ rate, and the price level.

The​ before-tax real wage: increases Employment: decreases Output: decreases The Price Level: increases The real interest rate: increases

​2.) Which of the following is true about the results of​ Ford's $5​ day?

Wages​ increased, productivity​ increased, and profitability increased.

Under the​ rational-expectations hypothesis,

a central bank cannot surprise the public​ systematically, and hence cannot use monetary policy to stabilize output.

When economists say that money is​ neutral, this means​ that:

a change in the money supply changes nominal variables but not real variables.

Classical economists argue that using fiscal policy to fight a recession​ doesn't make workers better off.​ Suppose, however, that the Keynesian model is correct. Relative to a policy of doing​ nothing, does an increase in government purchases that brings the economy to full employment make workers better​ off?

​Yes, because full employment is restored​ quickly, whereas if the price level must​ adjust, it may take a long time for full employment to be restored.

Does your answer change if​ (a) the Fed has some ability to forecast recessions or​ (b) price adjustment takes longer than six​ months?

If the Fed could forecast recessions​ well, or if the​ Fed's policy takes effect before firms adjust​ prices, it could stabilize the economy by using monetary policy appropriately before a recession begins.

What does the Keynesian model predict about monetary​ neutrality?

In the short​ run, changes in the money supply will affect output and the real interest rate while in the long​ run, these changes will only affect the price level

​3.) Which of the following was an observed effect of​ Ford's "efficiency​ wage?"

Increased productivity.

How is​ full-employment output affected by changes in labor​ supply?

Labor supply changes have no effect on the efficiency wage or​ employment; so they have no impact on​ full-employment output.

​1.) What are microeconomic​ foundations, and how do they figure into the disagreement between classical and Keynesian​ economists?

Models that incorporate microeconomic foundations explicitly include individual​ decision-making; they have historically been associated more with classical economics.

e. Determine the effects of a permanent increase in government purchases financed by a permanent increase in​ lump-sum taxes on the following variables in the current​ period, assuming that consumers respond to permanent increase in taxes by reducing their consumption in each period by the full amount of the tax increase and assuming that investment remains unchanged.

Output increases. The price level decreases. The real interest rate decreases

According to the Keynesian​ model, after an economic​ disturbance, which of the following is​ true?

Price adjustment will eventually return the economy to general​ equilibrium, but this may take several years.

c. The effort curve changes so that a higher real wage is needed to elicit the greatest effort per dollar in the primary sector. Effort exerted at the higher real wage is the same as before the change in the effort curve.

Primary​ market: decrease in employment and​ output, increase in the real wage. Secondary​ market: increase in employment and​ output, decrease in the real wage.

e. There is a temporary productivity improvement in the secondary sector.

Primary​ market: no change in employment and​ output, no change in the real wage. Secondary​ market: increase in employment and​ output, increase in the real wage.

Use the ​IS-LM model to determine the effects of an increased usage of automatic teller machines that reduces the effects of an increased usage of automatic teller machines that reduces the demand for money. Show the effects below on the general equilibrium values of real​ wage, employment,​ output, real interest​ rate, consumption,​ investment, and price level.

Real wage: Remains unchanged Employment: Remains unchanged Output: Remains unchanged Price Level: Increases Real Interest Rate: Remains unchanged Investment: Remains unchanged Consumption: Remains unchanged

According to the Keynesian IS−LM ​model, what is the effect of the following on​ output, the real interest​ rate, employment, and the price level of an​ economy? Distinguish between effects in the​ short-run and in the​ long-run. Your answers in each column should be relative to the original​ long-run equilibrium levels of each variable. A wave of investor pessimism about the future profitability of capital investments

Short-run: Output: Decrease Real Interest Rate: Decrease Employment: Decrease Price Level: Remains Unchanged Long-run: Output: Remains Unchanged Real Interest Rate: Decrease Employment: Remains Unchanged Price Level: Decrease

According to the Keynesian IS−LM ​model, what is the effect of the following on​ output, the real interest​ rate, employment, and the price level of an​ economy? Distinguish between effects in the​ short-run and in the​ long-run. Your answers in each column should be relative to the original​ long-run equilibrium levels of each variable. Increased tax incentives for saving (the tax breaks for investment are offset by lump - sum tax increases that keep current tax collections unchanged)

Short-run: Output: Decrease Real Interest Rate: Decrease Employment: Decrease Price Level: Remains Unchanged Long-run: Output: Remains Unchanged Real Interest Rate: Decrease Employment: Remains Unchanged Price Level: Decrease

According to the Keynesian IS−LM ​model, what is the effect of the following on​ output, the real interest​ rate, employment, and the price level of an​ economy? Distinguish between effects in the​ short-run and in the​ long-run. Your answers in each column should be relative to the original​ long-run equilibrium levels of each variable. An increase in consumer confidence, as consumers expect that their incomes will be higher in the future

Short-run: Output: Increase Real Interest Rate: Increase Employment: Increase Price Level: Remains Unchanged Long-run: Output: Remains Unchanged Real Interest Rate: Increase Employment: Remains Unchanged Price Level: Increase

According to the Keynesian IS−LM ​model, what is the effect of the following on​ output, the real interest​ rate, employment, and the price level of an​ economy? Distinguish between effects in the​ short-run and in the​ long-run. Your answers in each column should be relative to the original​ long-run equilibrium levels of each variable. Increased tax incentives for investment (the tax breaks for investment are offset by lump - sum tax increases that keep current tax collections unchanged)

Short-run: Output: Increase Real Interest Rate: Increase Employment: Increase Price Level: Remains Unchanged Long-run: Output: Remains Unchanged Real Interest Rate: Increase Employment: Remains Unchanged Price Level: Increase

In the Keynesian​ model, how does a temporary increase in government purchases affect the​ following? Your answers in each column should be relative to the original​ long-run equilibrium levels of each variable.

Short-run: Output: Increase Real Interest Rate: Increase Long-run: Output: Remains Unchanged Real Interest Rate: Increase

The discovery of a new technology increases the expected future marginal product of capital​ (MPK^f). a. Use the classical ​IS-LM model​ (with no​ misperceptions) to determine the direct effects of such an increase in the expected future marginal product of capital on the following curves. Answer only concerning which curves are directly affected by the change in the MPK^f​; do not list curves that shift to restore general equilibrium.

The LRAS curve does not shift. The FE line does not shift. The LM curve does not shift. The IS curve shifts up and to the right. The AD curve shifts up and to the right

Use the classical ​IS-LM model​ (with no​ misperceptions) to determine the direct effects of such an increase in the expected future marginal product of capital on the following curves. Answer only concerning which curves are directly affected by the change in the MPK^f do not list curves that shift to restore general equilibrium.

The LRAS curve does not shift. The FE line does not shift. The LM curve does not shift. The IS curve shifts up and to the right. The AD curve shifts up and to the right

How does the idea of labor hoarding help bring the prediction of the model into conformity with the business cycle​ facts?

The business cycle fact is that average labor productivity is mildly procyclical. If labor hoarding​ occurs, so that a given measured amount of employment produces less output during recessions and more output during​ expansions, then measured average labor productivity would be procyclical.

For each of the​ following, assume​ that, when the economy is in​ disequilibrium, only the labor market is out of​ equilibrium; assume also that for a short period firms are willing to produce enough output to meet the aggregate demand for output. a. Suppose that the price level is fixed in the short run so that the economy​ doesn't reach general equilibrium immediately after a change in the economy. Determine the​ short-run effects on the real interest rate and output when the expected rate of inflation falls b. Suppose that the price level is fixed in the short run so that the economy​ doesn't reach general equilibrium immediately after a change in the economy. Determine the​ short-run effects on the real interest rate and output when an increase in consumer optimism increases desired consumption at each level of income and the real interest rate. c. Suppose that the price level is fixed in the short run so that the economy​ doesn't reach general equilibrium immediately after a change in the economy. Determine the​ short-run effects on the real interest rate and output when there is an increase ​(temporarily) in government purchases. d. Suppose that the price level is fixed in the short run so that the economy​ doesn't reach general equilibrium immediately after a change in the economy. Determine the​ short-run effects on the real interest rate and output when there is an increase in​ lump-sum taxes, with no change in government purchases. Consider both the case in which Ricardian equivalence holds and the case in which it​ doesn't. e. Suppose that the price level is fixed in the short run so that the economy​ doesn't reach general equilibrium immediately after a change in the economy. Determine the​ short-run effects on the real interest rate and output when a scientific breakthrough increases the expected future MPK.

a. Real Interest Rate Rises; Output decreases b. Real Interest Rate Rises; Output increases c. Real Interest Rate Rises; Output increases d. When Ricardian Equivalence holds. Real Interest Rate remains unchanged; Output remains unchanged. When Ricardian Equivalence does not hold. Real Interest Rate falls; Output decreases. e. Real Interest Rate Rises; Output increases

Consider a permanent increase in government purchases of 100 per year​ (in real​ terms). The increase in purchases is financed by a permanent increase in​ lump-sum taxes of 100 per year. a. As compared with a temporary increase in government purchases that is also financed by a tax​ increase, such a permanent increase in government purchases

causes a larger income effect than a temporary increase in government purchases.

Regarding neutrality of​ money:

classical economists believe that money is neutral in both the short run and the long​ run, but Keynesians believe that money is neutral only in the long run but not in the short run due to sluggish adjustment of the price level in the short run.

Starting from a situation with no government spending and no​ taxes, the government introduces a foreign aid program​ (in which domestically produced goods are shipped​ abroad) and pays for it with a temporary​ 10% tax on current wages. Future wages are untaxed. What effects will the temporary wage tax have on labor​ supply?

decreases

According to the classical​ theory, a temporary increase in government purchases

does not affect labor demand but increases labor​ supply, lowers the real​ wage, and increases employment. shifts the IS curve up and to the right and the FE line to the right. If the shift of the FE line is smaller than the shift to the right of the IS ​curve, it leads to an increase in the real interest rate and an increase in the price level. According to classical​ economists, fiscal policy should not be used to smooth out the business cycle.

a. Under the assumption that real money demand depends on expected future​ output, use the classical​ IS-LM model to find the effects of an increase in expected future output on the current price level. For​ simplicity, assume that any effects of the increase in expected future output on the labor market or on desired saving and investment are small and can be ignored.

higher future output increases money​ demand, so the price level declines in equilibrium

In the classical​ model, money is neutral. This seems to be inconsistent with the business cycle fact​ that:

money is a​ leading, procyclical variable.

What problems do supply shocks create for Keynesian stabilization​ policies?

policy can do nothing to affect the location of the FE​ line; and using expansionary policy risks worsening the​ already-high rate of inflation

In the real business cycle​ theory, the primary source of cyclical fluctuations is

productivity shocks.

In order to explain the link between money growth and economic​ expansion, real business cycle theorists use the concept​ of:

reverse causation.

​2.) Classical economists

tend to support the idea of rational​ expectations, which goes along with their assumption that people pursue their own​ self-interest.

f. Consider a permanent increase in government purchases of 100 per year​ (in real​ terms). The increase in purchases is financed by a permanent increase in​ lump-sum taxes of 100 per year. Assume that after such a permanent increase in​ taxes, consumers respond by reducing their consumption each period by less than the full amount of the tax increase.​ Also, assume that investment is unaffected by any change in government purchases. As a result of these fiscal changes

the IS curve shifts up and to the right and the FE line shifts to the​ right; output​ increases, but the effects on the price level and real interest are​ ambiguous; they depend on the relative shifts of the IS curve and the FE line.

How is​ full-employment output determined in the Keynesian model with efficiency​ wages?

the amount of output produced by firms with employment determined by the labor demand curve at the point where the marginal product of labor equals the efficiency wage

The model of the macroeconomy that is used in the real business cycle theory is

the classical ​IS-LM model that assumes that prices adjust quickly to restore equilibrium.

The LM curve shows

the combinations of the real interest rate and output such that the asset market is in equilibrium.

The​ full-employment level of employment​ is:

the equilibrium level of employment reached after all wages and prices have fully adjusted.

What happens in the long run if policymakers increase the money supply​ appropriately?

the price level will be unchanged and employment will return to its​ full-employment level


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