Practice for Master Class 3 Chapter 5

Transcription

1 Practice for Master Class 3 Chapter 5 MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) In an economic model, an exogenous variable is A) determined outside the model. B) a variable that has no effect on the workings of the model. C) determined by the model itself. D) a stand-in for more complicated variables. 2) An economy that engages in international trade is called A) a modern economy. B) a cooperative economy. C) an engaged economy. D) an open economy. 3) An economy that has no interaction with the rest of the world is called A) a parochial economy. B) a rogue nation. C) a closed economy. D) an isolated economy. 4) A relationship that shows the technological possibilities for an economy as a whole is called a A) utility possibilities frontier. B) budget constraint. C) production possibilities frontier. D) production function. 5) The rate at which one good can be converted technologically into another is called A) the marginal rate of transformation. B) the rate of conversion. C) the marginal rate of substitution. D) the marginal product of labor. 6) An increase in total factor productivity shifts the production possibilities frontier A) downward, but does not change its slope. B) downward, and also changes its slope C) upward, but does not change its slope. D) upward, and also changes its slope. 7) A competitive equilibrium is a state of affairs in which A) markets clear, and output is maximized. B) all agents are equally well-off, and agents are price-takers. C) output is maximized, and all agents are equally well-off. D) agents are price-takers, and markets clear.

2 8) The presence of a distorting tax on wage income can result in A) MPN < MRTl,C. B) MPN < w. C) MRTl,C < MRSl,C. D) MRSl,C < MPN. 9) A competitive equilibrium has all of the following properties except A) MRSl,C = MRTl,C. B) MPN = w. C) MRTl,C = MP. D) MPN = slope of PPF. 10) A Pareto optimum requires all of the following except A) MRSl,C = MRTl,C. B) MPN = w. C) MPN = -slope of PPF. D) MRTl,C = MPN. 11) A competitive equilibrium is Pareto optimal if there is no way to rearrange or to reallocate goods so that A) no one can be made worse off. B) anyone can be made better off. C) someone can be made better off without making everyone else worse off. D) someone can be made better off without making someone else worse off. 12) A competitive equilibrium may fail to be Pareto optimal due to all of the following except A) externalities. B) inequality. C) non-price-taking firms. D) distorting taxes. 13) Relative to the social optimum, monopoly power directly leads to A) too little leisure. B) underproduction. C) too much leisure. D) overproduction. 14) The welfare theorems do not hold with a positive proportional wage tax because A) efficient allocations do not have the marginal rate of transfomation equal to the marginal rate of substitution. B) firms take the externality into account with they maximize profits. C) the marginal rate of transfomation is not equal to the marginal rate of substitution in the competitive equilibrium. D) firms do not take the externality into account when they maximize profits. 15) When the second welfare theorem holds A) total factor productivity is maximized. B) the real wage rate is efficient. C) an efficient allocation can be decentralized as a competitive equilibrium. D) a competitive equilibrium allocation is efficient.

3 16) The Solow residual attempts to measure changes in A) total factor productivity. B) the impact of government spending on aggregate output. C) changes in preferences for consumption vs. leisure. D) output produced above and beyond wage and dividend income. 17) An increase in government spending A) reduces consumption, reduces hours worked, and reduces the real wage. B) reduces consumption, increases hours worked, and reduces the real wage. C) reduces consumption, increases hours worked, and increases the real wage. D) increases consumption, increases hours worked, and increases the real wage. 18) Changes in government spending are not likely causes of business cycles because government spending-induced business cycles would, counterfactually, predict A) procyclical employment. B) countercyclical employment. C) countercyclical real wages. D) procyclical real wages. 19) Real business cycle theory argues that the primary cause of business cycles is fluctuations in A) total factor productivity. B) preferences. C) government spending. D) the importance of externalities. 20) The fact that hours worked are roughly constant over long periods of time suggests that increases in total factor productivity in the long run A) produce substitution and income effects that cancel each other out. B) produces no income effects. C) produces no substitution effects. D) produces a substitution effect which dominates the income effect. Answers 1) Answer: A 2) Answer: D 3) Answer: C 4) Answer: C 5) Answer: A 6) Answer: D 7) Answer: D 8) Answer: D 9) Answer: D 10) Answer: B 11) Answer: D 12) Answer: B 13) Answer: B 14) Answer: C 15) Answer: C 16) Answer: A 17) Answer: B 18) Answer: C 19) Answer: A 20) Answer: A

4 PROBLEMS 2. In a one-period model, taxes must be exactly equal to government spending. A reduction in taxes is, therefore, equivalent to a reduction in government spending. The result is exactly opposite of the case of an increase in government spending that is presented in the text. A reduction in government spending induces a pure income effect that induces the consumer to consume more and work less. At lower employment, the equilibrium real wage is higher because the marginal product of labour rises when employment falls. Output falls, consumption rises, employment falls and the real wage rises. 3. The only impact effect of this disturbance is to lower the capital stock. Therefore, the production possibility frontier shifts down and the marginal product of labour falls (the PPF is flatter). a.) The reduction in the capital stock is depicted in Figure 5.1. The economy starts at point A on PPF 1. The reduction in the capital stock shifts the production possibilities frontier to PPF 2. Because PPF 2 is flatter, there is a substitution effect that moves the consumer to point D. The consumer consumes less of the consumption good and consumes more leisure. Less leisure also means that the consumer works more. Because the production possibilities frontier shifts down, there is also an income effect. The income effect implies less consumption and less leisure (more work). On net, consumption must fall, but leisure could decrease, remain the same, or increase, depending on the relative strengths of the income and substitution effect. The real wage must also fall. To see this, we must remember that, in equilibrium, the real wage must equal the marginal rate of substitution. The substitution effect implies a lower marginal rate of substitution. The income effect is a parallel shift in the production possibilities frontier. As the income effect increases the amount of employment, marginal product of labour must fall from point D to point B. This reinforces the reduction in the marginal rate of substitution from point A to point D.

5 C PPF2 PPF1 B A D h I 2 I 1 l -G Figure 5.1 b.) Another event which would lower the capital stock would be a domestically fought war. In the aftermath of such a war, we would expect less output and consumption, and lower real wages. 5. If the government chooses G so as to make Y as large as possible, since the effect of an increase in G is to increase Y and decrease C, the government will increase G to the point where private consumption and leisure are zero, that is C = l = 0, as depicted in Figure 5.3 at point A. Clearly this is as poor a result as could be obtained, because welfare could not be any lower for the representative consumer. The consumer has to work to provide goods for the government, but gets no consumption goods and no leisure. Clearly, maximizing GDP is not a good strategy for the government, in general, as it matters what the composition of GDP is.

6 Figure Change in preferences. a.) At the margin, the consumer decides that leisure is more preferred to consumption. That is, the consumer now requires a bigger increase in consumption to willingly work more and consume less leisure. b.) To work out the effects of this change in tastes, we refer to Figure 5.5. The production possibility frontier in this example is unchanged. The consumer now picks a new point at which one of the flatter indifference curves is tangent to the production possibilities frontier. That is, equilibrium will shift from point A to point B. Consumption falls and leisure rises. Therefore, the consumer works less and produces less. Because employment has fallen, it also must be the case that the real wage increases.

7 C I 2 I 1 A B h l -G Figure 5.5 c.) This disturbance, which some might characterize as a contagious outbreak of laziness, would have the appearance of a recession, as output and employment both fall. The consequent reduction in consumption is also consistent with a typical recession. However, in this case the real wage would rise, which is inconsistent with the business cycle facts. Therefore, this type of preference change is not a cause of recessions.