ANALYTICAL PROBLEMS
1. Examine the effect of each of the following on output, the real interest rate, employment, and the price level in the short run and the long run. Use the Keynesian IS-LM graph to explain your answer.
a. A government builds more public housing, and construction firms invest more in machinery to speed up their housing construction.
b. The young generation has to save more to buy apartments in the future.
c. Firms move their offices and factories to other countries as a civil war begins in their home country.
d. More tourists and local consumers visit new theme parks and increase their spending.
2. Examine the effect of each of the following on output, the real interest rate, employment, and the price level in the short run and the long run. Use the Keynesian IS-LM graph to explain your answer.
a. After a financial crisis, people lose confidence in the financial market and prefer to hold more cash.
b. People use Bitcoin rather than money since more shops now accept it for transactions and banks accept it for deposits.
c. A nuclear power accident destroys factories and pollutes agricultural products, driving up price levels.
d. A new holiday scheme raises the morale and productivity of workers.
3. Suppose that the Fed has a policy of increasing the money supply when it observes that the economy is in recession. However, suppose that about six months are needed for an increase in the money supply to affect aggregate demand, which is about the same amount of time needed for firms to review and reset their prices. What effects will the Fed's policy have on output and price stability? Does your answer change if (a) the Fed has some ability to forecast recessions or (b) price adjustment takes longer than six months?
4. Classical economists argue that using fiscal policy to fight a recession doesn't make workers better off.
Suppose, however, that the Keynesian model is correct. Relative to a policy of doing nothing, does an increase in government purchases that brings the economy to full employment make workers better off? In answering the question, discuss the effects of the fiscal expansion on the real wage, employment, consumption, and current and future taxes. How does your answer depend on (a) the direct benefits of the government spending program and (b) the speed with which prices adjust in the absence of fiscal stimulus?5. Some labor economists argue that it is useful to think of the labor market as being divided into two sectors: a primary sector, where “good” (high-paying, longterm) jobs are located, and a secondary sector, which has "bad" (low-paying, short-term) jobs. Suppose that the primary sector has a high marginal product of labor and that (because effort is costly for firms to monitor) firms pay an efficiency wage. The secondary sector has a low marginal product of labor and no efficiency wage; instead, the real wage in the secondary sector adjusts so that the quantities of labor demanded and supplied are equal in that sector. Workers are alike, and all would prefer to work in the primary sector. However, workers who can't find jobs in the primary sector work in the secondary sector.
What are the effects of each of the following on the real wage, employment, and output in both sectors?
a. Expansionary monetary policy increases the demand for primary sector output.
b. Immigration increases the labor force.
c. The effort curve changes so that a higher real wage is needed to elicit the greatest effort per dollar in the primary sector. Effort exerted at the higher real wage is the same as before the change in the effort curve.
d. There is a temporary productivity improvement in the primary sector.
e. There is a temporary productivity improvement in the secondary sector.
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