REVIEW QUESTIONS

1. Which school of economists, classical or Keynesian, supports government intervention in the face of eco­nomic shock? Explain your answer based on the underlying assumptions.

2.

3. Define real shock and nominal shock. Give an example of each. What type of real shock do real business cycle economists consider the most important source of cyclical fluctuations?

4. What major business cycle facts does the RBC theory explain successfully? Does it explain any business cycle facts less well?

5. What is the Solow residual and how does it behave over the business cycle? What factors cause the Solow residual to change?

6. During a recession, some workers would urge the government to increase its purchases temporarily (for example, by building roads) so as to increase employment and raise wages. If you were a classical economist, would you agree with this statement?

Explain your answer in terms of the labor market, the FE-IS-LM model, and the practical difficulties associated with this approach.

7. An expansion of economic activities is observed to be followed by an increase in money supply. How would classical economists explain this—does the latter cause the former or vice versa? Explain.

8. According to the misperceptions theory, what effect does an increase in the price level have on the amount of output supplied by producers? Explain. Does it mat­ter whether the increase in the price level was expected?

9. In the classical model, money is neutral in both the short run and the long run. Explain how the intro­duction of price misperception and unanticipated change in monetary policy to the classical model changes the result of money neutrality.

10. Define rational expectations. According to the classical model, what implications do rational expectations have for the ability of the central bank to use mone­tary policy to smooth business cycles?

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