ECON 2315 Quiz
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
