Exam 1 (Ch. 1 - 4) Flashcards
According to the classical labor supply function, an equiproportionate rise in wages and all product prices would:
have no effect on the labor supply.
In the classical model, a rise in real aggregate demand:
raises prices.
The classical labor market assumes:
- an auction market
- perfectly flexible wages and prices
- perfect information
The marginal product of labor is
the change in output per each change in labor input.
A shift in the production functions is a result of:
- a change in capital stock over time
2. a technological change which alters the amount of output for given levels of input
If the marginal product of labor (MPN) exceeds the real wage rate (W/P) then
firms can increase profits by hiring more workers thereby causing the MPN to fall.
In the classical system, the supply of labor is a function of
the real wage.
In the classical model, if the production function is such that as employment increases the marginal product of labor (MPN) falls, then
the quantity of labor demanded will be negatively related to the real wage rate.
According to the classical economists, the level of individual satisfaction depends:
positively on both real income and leisure.
In the classical model, if a worker’s money wage rose from $10 to $20 while all product prices doubled this worker would:
supply the same amount of labor before and after the hourly wage increase.
An increase in the capital stock will cause
the production function to shift up raising the marginal product of labor (MPN) causing labor demand to increase.
What is the economic problem?
unlimited wants vs. scarce resources
Define microeconomics
individual household and firm decisions, emphasis on cost benefit analysis and decisions at the margin
Define macroeconomics
3 specifics
looking at the whole economy:
- employment
- national output (GDP)
- inflation
4 Classical Economists
Smith
Malthus
Ricardo
Mill
4 Neoclassical Economists
Marshall
Jevons
Pareto
Walras
Monetarist
Milton Freedman
GDP vs Real GDP vs GNP
Measure of all domestically produced final goods for a given period. Real GDP is adjusted for inflation.
GNP measure of final goods produced by American companies world wide
10 GDP Notes
- ignores depreciation
- only measures this year’s output
- does not measure changes in quality
- does not reflect value of intangibles (externalities)
- does not reflect the purpose of production
- doesn’t reflect things not for sale (mom’s jobs)
- does not reflect distribution of goods and services
- doesn’t measure illegal production
- doesn’t include transfer payments
- doesn’t include the sale of financial assets (bonds)
Injections v. Leakages
Injections:
- Investment
- Government Spending
Leakages:
- Savings
- Taxes
Injections = Leakages in equilibrium
5 Points of Mercantilism
- National power is goal of economic policy
- more gold = more national power
- gold comes from trading with foreigners
- gov’t subsidizes large companies (E India Trading)
- favor large numbers of wage workers
Focus is on accumulation of GOLD
Law of Diminishing Marginal Returns
when adding successively equal, extra units of one input, while holding all other inputs fixed, the amount of extra output will decline
Velocity will increase with
more frequent use of credit cards
In the classical theory, aggregate demand is determined by
the quantity of money
In the classical model, with a vertical aggregate supply curve, a reduction in government spending will
have no effect on aggregate demand
In the classical model, bond-financed government spending which pushes up the interest rate will result in
the crowding out of private consumption and private investment
In the classical system, an increase in government spending can be financed…
- taxes
- selling bonds
- creating new money
Using the classical theory of the interest rate, an increase in government spending financed by bonds will
leave aggregate demand unchanged as consumption and investment spending decrease by the exact amount of the increase in government spending
In the classical model, a reduction in the marginal income tax rate would
increase both the after tax real wage and the labor supply
In the classical model, if the marginal income tax rate were to increase then
the labor supply would decrease causing the aggregate supply curve to shift left
In the classical model, a decrease in government spending shifts the
demand of loanable funds to the left
In the classical system, what factors determine the interest rate?
- real savings
- the value of the gov’t deficit
- real investment demand
Explain the role of money in the classical system (3 uses). What role does money have in determining real output, employment, the price level, and the interest rate?
- Medium of Exchange—double coincidence of wants
- Unit of Account—understanding relative values
- Store of Value—holds your wealth
Quantity of money determines aggregate demand and therefore the price level.
Define “velocity of money”.
average number of times each dollar is used in transactions during a given period
Factors of velocity
(Price Level * Output) / Money Supply
What is the relationship between velocity and the Cambridge k?
V = (1/k)
Md = k * P * Y
What effect would an increase in the velocity of money have on output, employment, and the price level.
?
What determines the interest rate in the classical theory?
- Real savings
- The value of the government deficit
- Real investment demand
6 major policy conclusions of classical economics
- The economy is self adjusting and always tends towards full employment
- Wages and prices are fully flexible
- The interest rate adjusts to cushion in order to absorb any demand-side shocks that could affect output and employment
- Classical government policy = non-interventionist
- No restrictions on the markets
- Should keep monetary levels stable to stabilize prices
4 ways to calculate GDP
- sum all (price * quantities)
- Expenditures approach
- Incomes approach
- Value & sum intermediate goods
3 Price Indices
- Fixed basket, Laspeyres, overstates inflation
- Changing basket, Paasche, understates inflation
- Average of the two, Fisher
Pf = SQRT( Pl * Pp )
How does an increase in price affect the real wage? Firms?
Real wage will go down (w/p). Firms will hire more workers because MRN is higher.
How does an increase in nominal wage affect the real wage? Firms?
Real wage will increase (w/p). Firms will hire fewer workers.
What are the only factors that affect aggregate output?
- change in technology
- change in capital stock
- change in population
3 equations of exchange
- M * V = P * T
- M * V = P * Y (Income approach)
- Md = k * P * Y (Cambridge approach)
Loanable funds exogenous factors
- government deficit and demand
- business profit expectations
- household preferences about consumption and savings
What is the impact of a decrease in the marginal tax rate?
Labor supply shifts to the right because after-tax real wages increase. This causes output to shift right also. This is only done in emergencies.
Aggregate production function
Y = f ( K-bar, N )
Productivity of Thrift
Sr = Ir + ( G - T )
4 classical graphs
- Labor market
- Aggregate production function
- Price level
- Interest rate
Fiscal Policy
No impact except changes in the marginal tax rate
Tax Policy
No impact except crowding out
Monetary Policy
Only changes AD and therefore price level
What is true in the case of a negatively sloped labor supply curve?
income effect > substitution effect
