Chapter 7

Question 1

Wages and prices are fully flexible given

Answer 1

shifts in demand and supply.

Question 2

Full employment output is determined in two steps

Answer 2

obtain equilibrium labor employed in the labor market, and then determine full employment output using the production function

Question 3

1. Classical economics is based on the principle that prices:

Answer 3

adjust in a natural way to bring the markets for goods and labor into equilibrium.

Question 4

The school of economics that uses the tools of classical economics to
explain why economic booms and recessions occur is:

Answer 4

real business cycle theory.

Question 5

The assumption that distinguishes the classical model from Keynesian
models is that:

Answer 5

wages and prices adjust freely and quickly to all changes in demand
and supply.

Question 6

The relationship between output and labor in a model holding capital
stock fixed is known as the

Answer 6

short run production function

Question 7

Suppose that the stock of capital is held constant and the amount of
labor is increased. Beyond the point of diminishing returns output will:

Answer 7

increase at a decreasing rate

Question 8

An increase in the stock of capital makes the aggregate production
function:

Answer 8

shift up

Question 9

The demand for labor curve shows:

Answer 9

an inverse relationship between the real wage and the amount of labor
hired.

Question 10

If the real wage falls the:

Answer 10

a. marginal cost of labor falls.

b. firm will hire additional labor

Question 11

The substitution effect of a wage increase is the:

Answer 11

increase in labor supply associated with an increase in the

opportunity cost of not working.

Question 12

A higher wage rate will lead to increases in the amount of labor supplied if the:

Answer 12

b. substitution effect is stronger than the income effect.

Question 13

Suppose that firms reduce their capital stock. What should happen to
wages and the quantity of labor?

Answer 13

d. wages decrease, quantity of labor decreases

Question 14

As the result of an increase in capital the demand for labor would
_______, the supply of labor would ________, and the quantity of labor
hired would __________.

Answer 14

b. increase, remain the same, increase. People’s willingness to supply their labor is unchanged. Therefore the labor supply curve does not shift.

Question 15

As a result of immigration, the demand for labor would _______, the
supply of labor would ______, and the real wage would ________.

Answer 15

c. remain the same, increase, decrease. The demand for labor doesn’t change (this is of course assuming
that the immigrants don’t bring loads of money with them) but the labor supply
curve shifts out. Therefore employment increases and wages fall.

Question 16

Suppose that workers develop a greater taste for leisure. What should
happen to wages and the quantity of labor?

Answer 16

b. wages increase, quantity of labor decreases. The labor supply curve shifts back, demand does not change and
the new equilibrium is at a higher wage and lower employment. Higher wage
because ¯rms must bid up the wage to attract workers.

Question 17

If an economist observed that both wages and employment decreased in a
particular country, the economist would suggest that it was caused by:

Answer 17

a decrease in the demand for labor.

Question 18

The level of output produced when the labor market is in equilibrium is
called:

Answer 18

full-employment output.

Question 19

The argument that higher taxes lead to less employment is most likely to
hold if:

Answer 19

c. labor supply has a relatively flat slope.

Question 20

If labor supply is vertical,

Answer 20

b. tax increases will have no effect on output.

Question 21

Decreases in consumption, investment, or net exports caused by an
increase in government purchases are known as:

Answer 21

d. crowding out.