Macroeconomics Chapter 3

According to Okun's law, an increase in the unemployment rate will cause ________ in the level of employment and ________ in the level of output.

a decrease; a decrease

A person is more likely to increase labor supply in response to an increase in the real wage, the ________ is the income effect and the ________ is the substitution effect.

smaller; larger

The tendency of workers to supply more labor in response to a larger reward for working is called the ________ of a higher real wage on the quantity of labor supplied.

substitution effect

The income effect of a higher real wage on the quantity of labor supply is the

tendency of workers to supply less labor in response to becoming wealthier.

The ________ is the number of unemployed divided by the labor force and the ________ is the number of employed divided by the adult population.

unemployment rate; employment ratio

The ________ is the number of unemployed divided by the labor force and the ________ is the labor force divided by the adult population

unemployment ratio; participation rate

Full-employment output is the level of output that firms in the economy supply when

wages and prices have fully adjusted.

Frictional unemployment arises when

workers must search for suitable jobs and firms must search for suitable workers.

The labor force participation rate is the percentage of the adult population that is

working or actively looking for work.

According to Okun's law, if output grew 1% and full-employment output rose 3%, what would be the change in the unemployment rate?

1 percentage point

Suppose the marginal product of labor is MPN = 200 - 0.5N where N is aggregate employment. The aggregate quantity of labor supplied is 300 + 8w, where w is the real wage. What is the equilibrium real wage?

10

How many people are unemployed if the employment ratio is 75%, there are 90 million people employed, and there are 20 million people not in the labor force?

10 million

) What is the unemployment rate if there are 170 million people employed, 25 million people unemployed, and 35 million not in the labor force?

12.8%

Y doubles.

If Y = A × N × (75 + K/N), where K = 1000, N = 20, and A = 10, what happens if K doubles and N doubles?

it slopes upward from left to right, and the slope becomes flatter as the input increases.

The two main characteristics of the production function are

According to Okun's law, if output grew 7% and full-employment output rose 5%, what would be the change in the unemployment rate?

-1 percentage point

Assume that the full-employment level of output is $5000 billion and the natural unemployment rate is 5%. Suppose the current unemployment rate is 8%. What would be the current level of output according to Okun's law (when the Okun's law coefficient is 2)?

$4700 billion

According to Okun's Law, if the natural rate of unemployment is 5% and the actual unemployment rate is 4%, what is the level of full employment output if output equals $10,125 billion?

$9,926 billion

In each of the following scenarios, state whether the labor supply curve would shift to the left, to the right, not shift at all, or if the shift is ambiguous because there is more than one effect and they would move the curve in opposite directions. (a) The stock market rises sharply. (b) Fewer teenagers work while in school than before. (c) A large fraction of the population flees the country because of a bird flu epidemic. (d) The expected future wage declines and the stock market crashes. (e) The current real wage rate rises.

(a) Higher wealth shifts the labor supply curve left. (b) Lower participation rate shifts the labor supply curve left. (c) Smaller working-age population shifts the labor supply curve left. (d) The lower future wage shifts the labor supply curve to the right and the stock market crash reduces wealth, also causing the labor supply curve to shift to the right. (e) No effect; just a movement along the curve.

How would each of the following events affect the level of employment and the real wage rate? Explain which curves in the labor market diagram would be affected and show your work. (a) The stock market falls sharply. (b) A war destroys a substantial amount of a country's physical capital. (c) A new law reduces immigration of workers into the country.

(a) Lower wealth shifts the labor supply curve to the right; the new equilibrium has higher employment and a lower real wage. (b) The loss of capital lowers the marginal product of labor, reducing labor demand; the shift of the labor demand curve to the left lowers the real wage and employment. (c) Reduced labor supply causes a rise in the real wage rate in equilibrium and a decline in equilibrium employment.

Suppose a firm's hourly marginal product of labor is given by MPN = A (200 - N). (a) If A = 0.2 and the real wage rate is $10 per hour, how much labor will the firm want to hire? (b) Suppose the real wage rate rises to $20 per hour. How much labor will the firm want to hire? (c) With the real wage rate at $10 per hour, how much labor will the firm want to hire if A rises to 0.5?

(a) The firm will hire labor such that w = MPN, or 10 = 0.2(200 - N), so N = 150. (b) Now 20 = 0.2(200 - N), so N = 100. The firm's labor demand falls when the wage rate rises. (c) Now 10 = 0.5(200 - N), so N = 180. The increase in productivity increases labor demand.

How would each of the following events affect Cheryl Shirker's supply of labor? (a) Cheryl's firm announces a reorganization plan, in which she will get a big promotion and raise in six months. (b) Cheryl's speculative investment in plutonium futures pays off big, netting her a profit of $300 thousand. (c) Cheryl's father, who had planned to leave her a large bequest, must spend all his wealth on medical bills after a prolonged illness.

(a) The higher future real wage reduces current labor supply. (b) Higher wealth reduces labor supply. (c) Lower wealth increases labor supply.

The marginal product of labor (measured in units of output) of a firm is given by MPN = A(2000 - N) where A measures productivity and N is the number of labor hours used in production. Suppose the price of output is $6 per unit and A = 0.002. (a) What will be the demand for labor if the nominal wage is $18? (b) What will be the demand for labor if the nominal wage rises to $21?

(a) The real wage = $18/$6 = 3. Setting the real wage equal to the marginal product of labor gives 3 = 0.002(2000 - N), so 0.002N = 1, so N = 500. (b) The real wage = $21/$6 = 3.5. Setting the real wage equal to the marginal product of labor gives 3.5 = 0.002(2000 - N), so 0.002N = 0.5, so N = 250.

The aggregate supply of labor is the

) sum of the labor supplied by everyone in the economy.

What is the unemployment rate if there are 150 million people employed, 25 million people unemployed, and 25 million not in the labor force?

14.3%

Suppose the marginal product of labor is MPN = 200 - 0.5N where N is aggregate employment. The aggregate quantity of labor supplied is 300 + 8w, where w is the real wage. If a supply shock increases the marginal product of labor by 10 (to MPN = 210 - 0.5 N), by how much does employment increase?

16

Suppose the marginal product of labor is MPN = 200 - 0.5N where N is aggregate employment. The aggregate quantity of labor supplied is 300 + 8w, where w is the real wage. If a supply shock increases the marginal product of labor by 10 (to MPN = 210 - 0.5 N), by how much does the real wage increase?

2

The city of Hope has a labor force of 1000. Twenty people lose their jobs each month and remain unemployed for exactly one month before finding jobs. On January 1, May 1, and September 1 of each year, 50 people lose their jobs for a period of four months before finding new jobs. What is the average duration of an unemployment spell?

2.15 months

Suppose the marginal product of labor is MPN = 200 - 0.5N where N is aggregate employment. The aggregate quantity of labor supplied is 300 + 8w, where w is the real wage. What is the equilibrium quantity of employment?

380

The marginal product of labor (measured in units of output) for Expando Corp. is given by MPN = A(400 - N) where A measures productivity and N is the number of labor hours used in production. Suppose the price of output is $3 per unit and A = 2.0. What will be the demand for labor if the nominal wage is $18?

397

How many people are employed if the labor force participation rate is 60%, there are 3 million people unemployed, and there are 30 million people not in the labor force?

42 million

Assuming that the growth rate of full-employment output is 3%, and that the actual unemployment rate fell 2 percentage points in the last year, Okun's Law predicts that output growth rate over the past year was

7%

The city of Hope has a labor force of 1000. Twenty people lose their jobs each month and remain unemployed for exactly one month before finding jobs. On January 1, May 1, and September 1 of each year, 50 people lose their jobs for a period of four months before finding new jobs. What is the unemployment rate in any given month?

7%

What is the participation rate if there are 125 million people in the labor force, 100 million people employed, and 25 million not in the labor force?

83%

an increase in the real wage.

A decrease in the number of workers hired by a firm could result from

movement along the labor demand curve, causing an increase in the number of workers hired by the firm.

A decrease in the real wage would result in a

Which of the following events would lead to an increase in the marginal product of labor for every quantity of labor?

A favorable supply shock such as a fall in the price of oil

shift the production function up and increase marginal products at every level of employment.

A favorable supply shock would

Production Function

A mathematical expression relating the amount of output produced to quantities of capital and labor utilized is the

A

A supply shock that reduces total factor productivity directly affects which term in the production function Y = AF(K, N)?

shift the production function down and decrease marginal products at every level of employment.

An adverse supply shock would

a decrease in the real wage.

An increase in the number of workers hired by a firm could result from

a movement along the labor demand curve.

An increase in the real wage rate will cause

movement along the labor demand curve, causing a decrease in the number of workers hired by the firm.

An increase in the real wage would result in a

a supply shock.

An invention that speeds up the Internet is an example of A) an income effect.

A tremendous flood along the Mississippi River destroys thousands of factories, reducing the nation's capital stock by 5%. What happens to current employment and the real wage rate?

Both employment and the real wage rate would decrease.

the labor demand curve is negatively sloped.

Because of diminishing marginal productivity

An adverse oil-price shock reduces labor demand. What happens to current employment and the real wage rate?

Both employment and the real wage rate would decrease.

A beneficial oil-price shock increases labor demand. What happens to current employment and the real wage rate?

Both employment and the real wage rate would increase.

slowly; quickly

Changes in the capital stock occur ________, and changes in the amount of labor that firms employ occur ________.

it takes a long time for new investment and the scrapping of old capital to affect the overall quantity of capital.

Economists often treat the economy's capital stock as fixed because

A bird flu epidemic causes many people to flee the country, but does not affect labor demand significantly because almost all the goods produced within the country are exported. What happens to current employment and the real wage rate?

Employment would decrease and the real wage would increase.

A sharp increase in stock prices makes people much wealthier. If the main effect of this increased wealth is felt on labor supply, what happens to current employment and the real wage rate?

Employment would decrease and the real wage would increase.

The government announces a tax increase on workers' wages to take effect in the future. What happens to current employment and the real wage rate?

Employment would increase and the real wage would decrease.

is a straight line with constant upward slope.

If the marginal product of capital doesn't change as the amount of capital increases, a figure showing the relationship between output and capital

total factor productivity; the capital stock; the number of workers employed

In the production function Y = AF(K, N), A is ________, K is ________, and N is ________.

A

In the production function Y = AF(K, N), total factor productivity is

What two factors should you equate in deciding how many workers to employ?

The marginal product of labor and the real wage rate

Suppose oil prices fall temporarily, as oil becomes more plentiful. What impact is this likely to have on the production function, the marginal products of labor and capital, labor demand, employment, and the real wage?

More output can now be produced by the same amounts of capital and labor, since oil is more abundant and cheaper. The production function shifts upward, with the marginal products of labor and capital rising. Since the marginal product of labor is higher, so is labor demand. As a result of the shift to the right in the labor demand curve, employment rises, as does the real wage.

12.87.

Suppose that Freedonia has GDP equal to 2000 million, the capital stock is 1700 million, and the number of employees equals 70 million. The production function is Y = A . Total factor productivity of the economy is approximately equal to

20%

Suppose the economy's production function is Y = A . If K = 2000, N = 100, and A = 1, then Y = 246. If K and N both rise by 20%, and A is unchanged, by how much does Y increase?

3%

Suppose the economy's production function is Y = A . If K = 2000, N = 100, and A = 1, then Y = 246. If K rises by 10%, and A and N are unchanged, by how much does Y increase?

1.5

Suppose the economy's production function is Y = A . Suppose K = 200, N = 2000, and A = 1. Calculate the marginal product of capital.

1842

Suppose the economy's production function is Y = A . When K = 1000, N = 50, and A = 15, what is Y?

(a) From the production function, you can calculate that A = 1 in both 2000 and 2010, so A is unchanged. (b) Since output doubles (relative to the case in which Y = 399 in 2010) with the same amounts of capital and labor, A doubled.

Suppose the production function is Y = A . Suppose in 2000, K = 1000, N = 100, and Y = 199.5. In 2010, capital, labor, and output have doubled, so K = 2000, N = 200, and Y = 399. (a) By what percentage did productivity grow from 2000 to 2010? (b) If output had risen to 798 instead of 399, and capital and labor doubled, by what percentage would productivity have grown from 2000 to 2010?

Over the past 100 years, what has happened to the average workweek in the U.S. manufacturing industry? Why has this occurred? What are the implications for the size of the income and substitution effects?

The average workweek in manufacturing has declined from about 56 hours a week a century ago to just over 40 hours a week more recently. The primary reason for the decline in the workweek is the higher real wage. This suggests that the income effect of a permanently higher real wage dominates the substitution effect, as workers choose to have more leisure and to work fewer hours per week.

there is diminishing marginal productivity of capital.

The fact that the production function relating output to capital becomes flatter as we move from left to right means that

there is diminishing marginal productivity of labor.

The fact that the production function relating output to labor becomes flatter as we move from left to right means that

State the growth rate form of Okun's Law and define the variables in the equation.

The growth rate form of Okun's law is ΔY/Y = 3 - 2Δu, where ΔY/Y is the growth rate of output, 3 is the growth rate of full-employment output, and Δu is the change in the unemployment rate.

output from a one-unit increase in capital

The marginal product of capital is the increase in

decreases as the number of workers already employed increases.

The marginal product of labor

Suppose the natural rate of unemployment is 5%, with full-employment output of $7000 billion. Use Okun's Law to calculate the level of national output if the unemployment rate is 7%.

The output level form of Okun's law tells us that the percentage deviation of output from full-employment output equals minus two times the deviation of unemployment from the natural rate of unemployment. So, if the unemployment rate is 2 percentage points above the natural rate of unemployment, then output will be 4 percentage points below the full-employment level of output. So output will be (1 - 0.04) × $7000 billion = $6720 billion.

As a result of the superb economics essay that you wrote during this quarter, you won the Adam Smith prize of $100. The receipt of these funds would be an example of

a pure income effect.

How would each of the following events affect the level of employment and the real wage rate? (a) A tremendous boom occurs in the stock market, increasing people's wealth by $100 billion overnight. (b) A major government loan-guarantee program goes bust, losing $500 billion. To pay off the loss, the government announces that tax rates will rise 30% in the future. (c) A nuclear mishap contaminates all auto plants in the Detroit area, destroying their capital. (d) Medical science cures the common cold, causing fewer work days lost due to illness, thus greatly increasing labor productivity.

a) Increased wealth reduces labor supply; the shift of the labor supply curve to the left brings a new equilibrium with lower employment and a higher real wage. (b) The loss of wealth increases labor supply, leading to higher employment and a lower real wage. (c) The loss of capital lowers the marginal product of labor, reducing labor demand; the shift of the labor demand curve to the left lowers the real wage and employment. (d) Increased productivity increases the demand for labor; in equilibrium the real wage and employment increase.

Suppose the marginal product of labor in the economy is given by MPN = 200 - 0.5 N, while the supply of labor is 100 + 4w. (a) Find the market-clearing real wage rate. (b) What happens if the government imposes a minimum wage of 40? Is there involuntary unemployment? (c) What happens if the government imposes a minimum wage of 60? Is there involuntary unemployment?

a) The market-clearing real wage rate equates the demand and supply of labor. Setting w = MPN = 200 - 0.5 N and solving for N gives N = 400 - 2w, which represents labor demand. Equating labor demand to labor supply gives 400 - 2w = 100 + 4w, or 300 = 6w, or w = 50. (b) A minimum wage of 40 has no effect, as it is below the market wage, so involuntary unemployment is 0. (c) A minimum wage of 60 is binding, as it is above the market wage. At w = 60, labor demand is 400 - (2 × 60) = 280, while labor supply is 100 + (4 × 60) = 340. So unemployment is 60 workers.

Cyclical unemployment is caused by

business cycle fluctuations.

An adverse supply shock, such as a reduced supply of raw materials, would

decrease the marginal product of labor.

A winter ice storm has paralyzed the entire east coast, reducing productivity sharply. This supply shock shifts the marginal product of labor curve

down and to the left, reducing the quantity of labor demanded at any given real wage.

If Jeff's wage rate rises, he decides to work more hours. From this, we can infer that

for Jeff, the substitution effect is greater than the income effect.

If Jeff's wage rate rises, he decides to work fewer hours. From this, we can infer that

for Jeff, the substitution effect is less than the income effect.

The type of unemployment for which the net economic costs are most likely to be small is

frictional unemployment.

The equilibrium level of employment, achieved after the complete adjustment of wages and prices, is known as the

full-employment level of employment.

One reason that firms hire labor at the point where w = MPN is

if w > MPN, the cost (w) of hiring additional workers exceeds the benefits (MPN) of hiring them, so they should hire fewer workers.

Research on labor supply generally shows that

labor supply rises in response to a temporary increase in the real wage, but falls in response to a permanent increase in the real wage.

Cyclical unemployment arises when

output and employment are below full-employment levels.

A permanent increase in the real wage rate has a ________ income effect on labor supply than a temporary increase in the real wage, so labor supply is ________ with a permanent wage increase than for a temporary wage increase.

larger; less

) A technological breakthrough in using photons for computers will increase the productivity of those working with computers a hundredfold. You would expect this breakthrough to shift the

marginal product of labor curve up and to the right, raising the quantity of labor demanded at any given real wage.

Your boss wants to know if you should lay off any workers. You answer that you should lay off workers if the

marginal product of labor is less than the real wage rate.

Firms hire labor at the point where the

nominal wage rate equals the marginal revenue product of labor