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ECON 2020—Macroeconomics
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Question 1: Distinguish between the short run and the long run as they relate to macroeconomics.
Why is the distinction important?
Answer: For macroeconomists, the short run is a period in which wages (and other input prices)
do not respond to price level changes. There are at least two reasons why nominal wages may
remain constant for a while even though the price level has changed.
1.
Workers may not be aware of price level changes, and thus have not adjusted their
demands.
2.
Many employees are hired under fixed wage contracts.
Once sufficient time has elapsed for contracts to expire and nominal wage adjustments to
occur, the economy enters the long run a period in which nominal wages are fully responsive to
changes in the price level.
The economy will adjust itself to a long-run equilibrium, but in the short run there may be a
positive role for stabilization (fiscal and monetary) policy.
Question 2: Suppose the government misjudges the natural rate of unemployment to be much
lower than it actually is, and thus undertakes expansionary fiscal and monetary policy to try to
achieve the lower rate. Use the concept of the short-run Phillips Curve to explain why these
policies might at first succeed. Use the concept of the long-run Phillips Curve to explain the longrun outcome of these policies.
Answer: In the short-run there is probably a tradeoff between unemployment and inflation. The
government’s expansionary policy should reduce unemployment as aggregate demand increases.
However, the government has misjudged the natural rate and will continue its expansionary policy
beyond the point of the natural level of unemployment. As aggregate demand continues to rise,
prices begin to rise. In the long-run, workers demand higher wages to compensate for these
higher prices. Aggregate supply will decrease (shift leftward) toward the natural rate of
unemployment.
In other words, any reduction of unemployment below the natural rate is only temporary and
involves a short-run rise in inflation. This, in turn, causes long-run costs to rise and a decrease in
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ECON 2020—Macroeconomics
aggregate supply. The end result should be an equilibrium at the natural rate of unemployment
and a higher price level than the beginning level. The long-run Phillips curve is thus a vertical line
connecting the price levels possible at the natural rate of unemployment found on the horizontal
axis. (See Figure 15.9 in the text.)
Question 3. What are the four supply factors of economic growth? What is the demand factor?
What is the efficiency factor?
Answer: The four supply factors are the quantity and quality of natural resources; the quantity and
quality of human resources; the stock of capital goods; and the level of technology. The demand
factor is the level of purchases needed to maintain full employment. The efficiency factor refers to
both productive and allocative efficiency.
Question 4. Productivity often rises during economic expansions and falls during economic
recessions. Can you think of reasons why? Briefly explain. (Hint: Remember that the level of
productivity involves both levels of output and levels of labor input.)
Answer: Productivity would be likely to rise during economic expansions because the low rate of
unemployment would encourage the more intensive use of existing plant and equipment and
current workforce. Worker productivity would be likely to fall during recessions because employers
would be reluctant to discharge valuable workers until absolutely necessary.
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