Download QUIZ 2: Macro – Winter 2002

QUIZ 5: Macro – Winter 2010
Name:
______________________
Section Registered:
Campus
Evening
For each of the following questions (1-8), circle the answers that make the statements true.
Consider the standard model we have build in class. When answering these questions,
assume all other exogenous variables (including TFP) are held constant. Also, assume all
changes in exogenous are unexpected, unless told otherwise. Lastly, throughout, assume that
the capital stock is fixed. (16 points total – 2 points each).
1.
A permanent increase in TFP will shift the labor supply curve _________.
a. definitely to the right
b. definitely to the left
c. either to the right or to the left depending on the strength of the income effect
relative to the substitution effect
d. it will not shift the curve
This is because of the income effect on labor supply. Labor supply will always shift left
as TFP increases. The question is how far it shifts left (this is dependent on the strength
of the income effect relative to the substitution effect).
2.
A permanent increase in labor income taxes will shift the long run aggregate supply
curve __________.
a. definitely to the right
b. definitely to the left
c. either to the right or to the left depending on the strength of the income relative to
the substitution effect
d. it will not shift the curve
The long run aggregate supply curve is Y*. Y* increases because of changes in A, K and
N*. A and K are fixed. Whether Y* increases or decreases, therefore, depends on whether
N* increases or decreases. This depends on the strength of the income and substitution
effects from the tax changes
3.
A permanent increase government spending will shift the long run aggregate supply
curve _________.
a. definitely to the right
b. definitely to the left
c. either to the right or to the left depending on the strength of the income effect
relative to the substitution effect
d. it will not shift the curve
The long run aggregate supply curve is Y*. Y* increases because of changes in A, K and
N*. A and K are fixed. Changes in G have no effect on N* (it does not affect labor demand
nor does it affect labor supply). So, Y* does not change as G changes!
4.
A permanent fall in household wealth will shift the long run aggregate supply curve
_________.
a. definitely to the right
b. definitely to the left
c. either to the right or to the left depending on the strength of the income effect
relative to the substitution effect
d. it will not shift the curve
As wealth falls, PVLR falls. This will shift the labor supply curve right increasing N*
(we did this on the midterm AND last week’s quiz). As a result of N* increasing, Y*
will increase (given that A and K are held fixed).
5.
A permanent increase in TFP will shift the IS curve ________.
a. definitely to the right
b. definitely to the left
c. either to the right or to the left depending on the strength of the income effect
relative to the substitution effect
d. it will not shift the curve
An increase in TFP will increase both C - because PVLR will increase - and the
autonomous portion of I (I(.)) – because of the complementarity between TFP and
capital through the cobb-douglas production function.
6.
A permanent increase in labor income taxes will shift the IS curve _________.
a. definitely to the right
b. definitely to the left
c. either to the right or to the left depending on the strength of the income effect
relative to the substitution effect
d. it will not shift the curve
A permanent increase in labor income taxes will reduce after tax wages
(unambiguously) which will reduce after tax PVLR. This means consumption will fall
(C(.)) which will shift the IS curve to the right.
7.
A permanent increase government spending will shift the IS curve ________.
a. definitely to the right
b. definitely to the left
c. either to the right or to the left depending on the strength of the income effect
relative to the substitution effect
d. it will not shift the curve
This was easy. The IS curve is the graphical representation of Y = C + I + G in {Y,r}
space. An increase in G will increase Y (for all levels or r). This is represented by a
rightward shift of the IS curve.
8.
A permanent fall in household consumer confidence will shift the IS curve _______.
a. definitely to the right
b. definitely to the left
c. either to the right or to the left depending on the strength of the income effect
relative to the substitution effect
d. it will not shift the curve
A fall in consumer confidence is represented as a decline in C(.) which shifts the IS
curve to the right.
Reading Question: (4 points total)
In the Economist article “The Lessons of 1937” (6/20/2009), Christy Romer (chair of the
President’s Council of Economic Advisors) recounted the story the recession of 1937.
According to Christy (and many other academics), what caused the recession of 1937?
Your answer should not exceed 5-7 words. My ideal answer is only 5 words. We will give
credit for lots of related answers.
Contractionary monetary and fiscal policy.
Monetary policy is the use of interest rates to stabilize the economy. In 1937, the Fed
raised the reserve ratio (limiting bank lending). We will talk about this mechanism in
class this week. Reducing bank lending reduces output in the short run (as we will see
in class soon).
Fiscal policy is the use of government spending and taxes to stabilize the economy. In
1937, tax revenues increased (they collected social security taxes) and they limited
spending. Both pressures contributed to an economic downturn.
After the great depression, the economy was week. It was being sustained by policy
makers (both monetary and fiscal policy). Once they took those policies away, the
economy collapsed.
The question we will ask is whether a collapse today or lower growth tomorrow (to pay
back the deficits) is the more prudent policy option.