REVIEW QUESTIONS

1. Define efficiency wage. What assumption about worker behavior underlies the efficiency wage theory? Why does it predict that the real wage will remain rigid even if there is an excess supply of labor?

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3. How do the assumptions of prices in the Keynesian and classical models have different implications on monetary policy?

4. Define menu cost. Why might small menu costs lead to price stickiness in monopolistically competitive markets but not in perfectly competitive markets? Why can a monopolistically competitive firm profit­ably meet demand at its fixed price when actual demand is greater than the firm anticipated?

5. What does the Keynesian model predict about monetary neutrality (both in the short run and in the long run)? Compare the Keynesian predictions about neutrality with those of the basic classical model and the extended classical model with misperceptions.

6. In the Keynesian model, how do increased govern­ment purchases affect output and the real interest rate in the short run? In the long run? How do increased government purchases affect the composition of output in the long run?

7. Describe three alternative responses available to poli­cymakers when the economy is in recession. What are the advantages and disadvantages of each strategy? Be sure to discuss the effects on employment, the price level, and the composition of output. What are some of the practical difficulties in using macroeco­nomic stabilization policies to fight recessions?

8. Use the Keynesian model to explain the procyclical behavior of employment, money, inflation, and investment.

9. Why does the classical model perform better than the Keynesian model in explaining the business cycle fact of procyclical labor productivity? How can the con­cept of labor hoarding help Keynesians improve their model's prediction?

10. According to the Keynesian analysis, in what two ways does an adverse supply shock reduce output? What problems do supply shocks create for Keynesian stabilization policies?

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