Spring 2000: Homework 3-

1. Answer true or false:

a. The civilian labor force for a country includes people serving in the military for that country.

b. When an economy operates at full employment there is no frictional or structural unemployment.

c. A family member (over age 16) who works for a family enterprise for eighteen hours a week without pay is considered unemployed.

d. The money used in the U.S. is an example of commodity money.

e. An equal percentage increase in the wage rate and the price level will result in an increase in nominal wages and no increase in real wages.

f. The opportunity cost of making transactions increases during a period of inflation.

g. A significant limitation of the CPI relates to substitution bias since the CPI is calculated using a fixed market basket that does not vary as relative prices vary.

h. The Classical Model explains why over a long enough period of time the overall economy tends to be at full employment.

i. The Classical Model focuses primarily on nominal values.

j. In the Classical Model prices in each market adjust until the quantity demanded equals the quantity supplied in each market.

k. In the Classical Model leakages from the income-expenditure stream include taxes, saving, and exports.

l. In the Classicl Model injections into the income-expenditure stream include consumption, investment, and government spending.

m. An increase in capital, holding everything else constant, will result in an increase in labor productivity.

n. Consider a ray from the origin that goes through a particular point on the aggregate production function.  We know that the flatter the ray from the origin (or the smaller the slope of the ray) the greater is the measure of labor productivity.

o. An increase in government spending, holding everything else constant, will result in crowding out in the Classical Model because interest rates increase.

p. An increase in the interest rate, holding everything else constant, will cause a shift out of the supply of funds curve.

q. An increase in the money supply, holding everything else constant, has no impact on real GDP in the Classical Model.

r. An increase in the money supply, holding everything else constant, will lead to an increase in the price level in the Classical Model.

s. An aggregate production function as studied in the Classical Model illustrates the law of diminishing returns to labor.

t. Economic growth in the Classical Model can occur if the supply of labor or the demand for labor increases.

u. Full employment occurs when cyclical unemployment is 4% for the aggregate economy.

v. The government adjusts all employment data for seasonal and cyclical variation.

2. Suppose you are analyzing the state of your country=s economy using a Classical Model.  You know what the labor market looks like and you also know your country=s aggregate production function.

a. Draw a sketch of your country=s labor market and a sketch of your country=s aggregate production function.  Label each axis clearly, label all lines on your graph, and also label the equilibrium wage rate, the equilibrium level of employment in your economy and the equilibrium level of real GDP in your economy.

b. Suppose the labor supply curve for your economy shifts in.  Illustrate this shift on your graph labelling any new curves clearly.

i. What happens to the wage rate relative to its initial level?

ii. What happens to the equilibrium level of employment relative to its initial level?

iii. What happens to real GDP relative to its initial level?

iv. What happens to labor productivity?  Explain your answer.

c. Suppose instead of the labor supply curve shifting, your economy experiences an increase in the level of capital available (hold everything else constant).

i. What happens to the equilibrium level of real GDP relative to its initial level?

ii. What happens to labor productivity?

3. Consider the Classical Model and the loanable funds market.  Suppose the demand for funds for the government increases holding everything else constant.

a. What will happen to the equilibrium rate of interest?

b. What will happen to the level of private investment in the economy?

c. What will happen to the level of savings in this economy?

d. What will happen to the level of consumption in this economy?

e. What will happen to the deficit of the government in this economy?