Chapter 17New Classical Macro Confronts New Keynesian Macro
1)Which of the following is an important assumption about the labor market that is shared by both the original Keynesian model and the Friedman "Fooling Model?"
A)the supply of labor depends on expected real wages
B)the demand for labor is a function of nominal wages
C)workers can be "off" their labor supply function in the short-run equilibrium
D)firms can be "off" their labor demand function in the short-run equilibrium
2)According to Gordon which of the following statements about Friedman's fooling model is accurate?
A)the demand for labor depends on the nominal wage
B)as prices increase, firms will offer higher real wages; these higher wages will bring forth an increase in the supply curve of labor
C)the supply curve of labor depends on the expected real wage
D)All of the above statements are accurate.
3)Which of the following are NOT included among Gordon's criticisms of Friedman's fooling model?
A)workers buy many goods on a weekly basis and thus could discover quite quickly that prices had risen
B)workers could discover movements in the aggregate price level fairly easily
C)the model relied on a non-market-clearing explanation of the labor market
D)workers would predict higher prices if policies that led to higher prices in the past were used again
Figure 17-1
4)In the Friedman "Fooling Model" a ______causes the labor supply curve to shift, and in Figure 17-1, if the initial equilibrium is at point C then, the new level of price expectations, POe is ______than the initial level of Pe.
A)change in the money supply; less than
B)change in real wages; less than
C)change in nominal wages; greater than
D)change in price expectations; greater than
5)In the Friedman "Fooling Model" if P(e) is less than P then the labor supply curve in Figure 17-1
A)shifts leftward when workers realize their error
B)always shifts rightward.
C)initially remains the same.
D)Both A and C are correct.
6)The actual real wage must be below the equilibrium real wage in order to encourage firms to produce at any output level above the natural rate. Once workers realize this situation, their expected price level will gradually rise and they will demand a higher nominal wage. This description of a business cycle adjustment is part of which of the following theories?
A)Classical model
B)original Keynesian model
C)Friedman fooling model
D)the RBC model
7)Which of the following assumptions is found in Friedman's model but not in the new classical model?
A)supply of labor depends on expected real wage
B)workers gradually adapt their expectations of the price level to the actual price level
C)imperfect information
D)market-clearing labor market
8)Which of the following statements best describes the rational expectations hypothesis?
A)individuals will not enter into long-term agreements unless they are certain about the payments they will receive
B)it is likely that individuals will consistently make errors
C)individuals will make random errors, independent of previous errors
D)it is reasonable to expect individuals to consistently underestimate the level of inflation
9)Which of the following best describes the policy ineffectiveness proposition?
A)monetary policy cannot change real GDP in a regular or predictable way
B)policymakers can be effective in changing real GDP only if people's expectations are correct
C)monetary policy can change real GDP only if the Fed pursues a consistent, stable growth rate of the real money supply
D)fiscal policy is totally ineffective in changing real GDP in both the short run and the long run
10)Business cycles will occur if either of the two theories below characterizes the behavior of the economy
A)the classical or the Keynesian theories of aggregate demand.
B)the classical or the real balance theory.
C)deflation impotence or rigid nominal wages.
D)A and C.
11)According to Gordon, a major problem with Keynes "rigid nominal wage" theory of the business cycle is
A)a horizontal LM curve.
B)it is not a market clearing theory.
C)falling real wages are not countercyclical with business activity or Y.
D)None of the above.
12)If imperfect information characterizes workers' behavior then there will be a
A)slow adjustment of the demand for labor, Nd.
B)rapid adjustment of the demand for labor, Nd.
C)rapid adjustment of both the demand for labor, Nd, and the supply of labor, Ns.
D)a lagged adjustment of the equilibrium level of employment, Ns.
13)If it is less costly for business firms to adjust the labor demanded as the price level changes than it is for households to adjust Ns, then in the short-run
A)Ns has a positive slope and the demand for labor (Nd) negative slope.
B)Nd has a negative slope and the supply of labor (Ns) a positive slope.
C)AD has a negative slope.
D)SAS has a positive slope.
14)If forecasting errors are rational then
A)people will always be error-prone.
B)they will be random, and thus independent of previous errors.
C)they will be independent of business firm production and price forecasts.
D)A and C are both correct.
15)If the markets in the economy are characterized by rational expectations then
A)predictable changes cause neither the AD nor the SAS curves to shift.
B)predictable changes in monetary policy are ineffective in changing output.
C)unpredictable monetary policy is ineffective in changing prices.
D)unpredictable fiscal policy is ineffective in changing prices.
16)A positive "price surprise" will result in a
A)leftward shift in the short-run SAS curve.
B)leftward shift in the short-run AD curve.
C)rightward shift in the short-run AD curve.
D)rightward shift in the short-run SAS curve.
17)Switzerland has experienced the lowest rate of price increases in the post World War II period. Consequently, Lucas would predict
A)small supply responses to variations in the inflation rate.
B)large supply responses to variations in the inflation rate.
C)small demand responses to variations in the inflation rate.
D)large demand responses to variations in the inflation rate.
18)Which of the following theories of business cycles implies that efficient markets, characterized by perfect information and by rational business firms and households, will still be characterized by business cycles?
A)Lucas's rational expectation model
B)the natural rate hypothesis
C)the real business cycle model
D)classical theory
19)According to the real business cycle theory, the supply side shock from dramatic increases in oil prices in the 1970's led to higher unemployment because
A)when the real wage, W/P, fell workers chose leisure.
B)when the real wage, W/P, rose workers chose leisure.
C)workers increase Pe.
D)None of the above.
20)According to the classical model, real wages should
A)remain constant.
B)fall during recessions.
C)rise during recessions.
D)stay the same during recessions but rise during expansions.
21)According to the Keynesian model, real wages should
A)remain constant.
B)fall during recessions.
C)rise during recessions.
D)stay the same during recessions but rise during expansions.
22)According to the Real Business Cycle model real wages should
A)remain constant.
B)fall during recessions.
C)rise during recessions.
D)stay the same during recessions but rise during expansions.
23)Of the four models of the business cycle, which model's implication concerning the change in real wages during recessions is consistent with actual observed changes in real wages during recessions?
A)the Real Business Cycle theory
B)the Friedman-Lucas Model
C)the Keynesian Model
D)None of the above.
24)The new Keynesian models, are examples of
A)market clearing, wage rigidity models.
B)non-market clearing, wage rigidity models.
C)imperfect information, wage rigidity models.
D)perfect information, non-clearing market models.
25)In the short-run, a supply shock will lead to
A)movement of prices and output in the same direction.
B)movement of prices and output in opposite directions.
C)a sustained inflation.
D)a movement in prices, but not output.
26)A supply shock, such as the OPEC oil-price increases in the 1970s,
A)can lead to accelerating inflation, if an accommodation policy tries to maintain the pre-shock level of real GDP.
B)will cause lower real wages in long-run equilibrium.
C)will reduce the natural level of real GDP.
D)both B and C.
27)A supply shock that reduces labor productivity
A)causes accelerating inflation if the Fed attempts to maintain the original output level.
B)will increase real wages if nominal wages are flexible.
C)will reduce the level of output at the natural level of real GDP even if employment does not decline.
D)A and C.
28)Which of the following is not a reason why natural GDP might fall as a result of a supply shock?
A)the production function shifts downward
B)there might be a voluntary decline in the supply of labor in response to the decline in real wages
C)the supply of labor is a function of the expected wage rate
D)none of the above
29)An adverse supply shock with a vertical supply of labor curve will
A)raise the price level and leave unemployment unchanged.
B)raise unemployment and lower the price level.
C)raise both unemployment and the price level.
D)lower both unemployment and the price level.
30)The natural real GDP will _____ following a fall in energy prices because
A)rise; labor productivity increases.
B)fall; labor productivity declines.
C)rise; employment is more attractive relative to leisure.
D)a and c are both correct
31)The natural real GDP will _____ following a rise in energy prices because
A)rise; labor productivity increases.
B)fall; labor productivity increases.
C)fall; real wages are flexible and employment is less attractive relative to leisure.
D)b and c are both correct.
32)A principle difference between the original Keynesian model and the new Keynesian model is that in the new version
A)the traditional assumptions of profit maximization is no longer included.
B)monetary policy is impotent.
C)wages and prices adjust slowly to market conditions.
D)All of the above are correct.
33)A principle difference between the new Classical and the new Keynesian models has to do with the choices made by business firms. We find that
A)new classical business firms choose the output level given the price level, while new Keynesian firms choose the price level given the level of output.
B)new classical business firms choose the price level given the output level, while new Keynesian firms choose the output level given the level of output.
C)both new classical and new Keynesian firms select the price level, but only new classical firms select the output level.
D)both new classical and new Keynesian firms select the output level, but only Keynesian firms select the price level.
34)One of the major weaknesses of the original Keynesian approach to the business cycle was
A)the assumption that firms were perfectly competitive.
B)the failure to explain why wages were rigid.
C)the denial of the existence of the Pigou effect.
D)the assumption that the demand for labor depended on the real wage.
35)Staggered, overlapping contracts mean
A)the contract between workers and firms can be opened for renegotiation if other key firms in the industry have signed a new contract within the last ninety days.
B)each firm within an industry agrees to negotiate with the union according to a schedule.
C)not all labor contracts within the economy expire at the same time.
D)different contracts are reached for the different skill classifications of workers within a firm.
36)Gordon argues that individual workers and firms prefer long-term contracts, but that such contracts
A)raise the costs of doing business, a macroeconomic externality.
B)insure that output alone is adjusted as AD changes and therefore, such contracts impose high costs of output and employment instability on society.
C)insure that the price level alone is adjusted as AD changes and therefore, such contracts impose high costs of output and employment instability on society.
D)insure a macroeconomic externality, rigid unemployment.
37)Long-term contracts are desirable for both firms and workers for each of the following reasons EXCEPT one. Which of the following does not explain the desirability of long-term contracts?
A)wage negotiations are costly and time consuming on both sides
B)contracts insulate workers from changing economic conditions such as decreases in aggregate demand
C)the incidence of strikes decreases because the contracts are binding for three years
D)contracts reduce uncertainty
38)Higher consumer prices caused by external forces would boost the wage costs of firms without any commensurate increase in the nominal demand for their products if
A)long-term contracts were in force.
B)all labor contracts were one year in duration.
C)there were no COLAs.
D)there were full COLA protection.
39)Assuming that workers will be pushed off their labor supply curve in response to a change in aggregate demand is part of which of the following theories?
A)Classical
B)Keynesian
C)New Classical
D)Both Classical and Keynesian
40)According to the original Keynesian model, there would be counter-cyclical movements of the real wage rate in response to changes in aggregate demand because
A)firms react to nominal wages and workers respond to real wages.
B)firms react to real wages and workers respond to the expected real wage.
C)firms are on their labor demand curve and workers are off their labor supply curve.
D)firms are off their labor demand curve and workers are on their labor supply curve.
41)In the non-market clearing model, "involuntary" unemployment results because
A)real wages are too high.
B)real wages rise when aggregate demand increases.
C)real wages fall when aggregate demand increases.
D)wages and prices are sticky.
42)Under the assumptions of the new Keynesian model, an increase in aggregate demand will
A)increase prices and output in the short-run.
B)lead to a decrease in unemployment and an increase in prices in the short run.
C)lead to an increase in the nominal wage rate in the long run and a decrease in unemployment in the short run.
D)All of the above are correct.
43)According to the new Keynesian economists, SAS adjusts slowly to a change in AD because of
A)high menu costs.
B)staggered overlapping wage contracts.
C)efficiency wages.
D)All of the above combinations explain slow adjustments in SAS.
44)Gordon believes that the new Keynesian approach as opposed to other business cycle theories is preferred because
A)it explains information barriers and sticky wages.
B)it explains how workers are "fooled."
C)it explains wage and price stickiness assuming rational firms and workers.
D)it identifies the source of supply side shocks and slow SAS adjustment.
45)Which of the following theories fails to explain persistent unemployment?
A)classical theory
B)Friedman's fooling theory
C)new Keynesian theory
D)Both A and B are correct.
46)Which explanation for persistent unemployment used by the original Keynesian model is no longer needed in the new Keynesian model?
A)shifting IS curve
B)a fixed nominal wage
C)aggregate supply curve is a function of the nominal wage
D)rigid wages and prices
47)The new Keynesian economists argue that prices are relatively rigid because of
A)menu costs.
B)overlapping staggered contracts.
C)efficiency wages.
D)All of the above.
48)The use of bar codes, computerized price lists, and scanners in supermarkets is an
example of
A)menu costs.
B)implicit contracts.
C)efficiency pricing.
D)All of the above.
49)In 1989, Sears and Roebuck closed its stores and remarked every price in its stores to reflect a new "lower everyday" pricing strategy. Sears must have believed at that time that
A)the profit from extra sales were less than additional menu costs.
B)the menu costs were less than the gain in profits from additional sales.
C)extra liquidity was more important than menu costs.
D)B and C.
50)American automobile manufacturers and dealers appear to adjust the price (sticker prices plus financing charges) by periodically changing interest rates and by using rebates and surcharges as opposed to directly changing sticker prices. Assuming that they maximize their profits, this pricing approach may reflect
A)a relatively low cost to adjust sticker prices.
B)a relatively low cost to adjust advertising.
C)a relatively high cost to adjust sticker prices.
D)a relatively high cost of advertising.
51)Suppose that firms are paying their "efficiency wage" rate and AD shifts leftward. Firms that lower wages and maintain production would
A)achieve lower profits since worker efficiency would fall and total wages paid increase.
B)achieve lower profits since worker efficiency would fall and wages per unit of output increase.
C)achieve higher profits.
D)achieve lower per unit wage costs.
52)Gordon suggests that full indexation of production costs to nominal AD would solve the macroeconomic externality. However, individual firms would be unlikely to extend full indexation to their workers because
A)its local customers may not buy its products at the new price level.
B)its suppliers may reside in foreign countries and are therefore, not subject to indexation.
C)other competitor firms will not index their wages.
D)All of the above.
53)In the "non-market clearing model" the level of final goods sales and unemployment during a recession are
A)the result of interactions between supply and demand.
B)higher than would be the case in a market clearing model.
C)caused by the rapid adjustment of prices and wages.
D)the result of wage and price rigidities.
Figure 17-2 represents a monopolist faced with a decrease in the demand for her product. She initially charges P0 and produces Q0.