ANSWERS TO END-OF-CHAPTER PROBLEMS
CHAPTER 6
Quick Check
1.
a.
b.
c.
d.
e.
f.
g.
h.
2.
3.
False.
False.
False. 44% of unemployed workers leave the unemployment pool each month.
True.
False.
Uncertain/False. Most workers have some bargaining power, depending upon how easy
they are to replace. Workers in low skill, entry level jobs may have very little or no
bargaining power.
True.
False.
a.
Putting aside the 3.5 million who move from job to job, the average flow is
(1.5+1.7+1.8+1.5)/127=5.1%
b.
1.8/7.0=25.7%
c.
(1.8+1.3)/7.0=44.3%. Duration is 1/.443 or 2.3 months.
d.
(1.5+1.1+1.7+1.3)/66.7=5.6=8.4%.
e.
As a percentage of flows into the labor force, new workers account for
0.4/(1.5+1.8)=12%. As a percentage of flows into and out of the labor force, new
workers account for 0.4/5.6=7%.
a.
W/P=1/(1+)=1/1.05=.95
b.
From the wage setting relation, un=1-W/P=5%
c.
W/P=1/1.1=.91; u=1-.91=9%. The natural rate of unemployment rises. The increase in
the markup is essentially a fall in labor demand (actually a shift of the labor demand
curve). Intuitively, less competition in the product market leads to lower desired output
by firms and therefore to a fall in labor demand. The fall in labor demand increases
unemployment and reduces the real wage.
Dig Deeper
4.
a.
Answers will vary.
b-c.
Most likely, the job you will have ten years later will pay a lot more than your reservation
wage at the time (relative to your typical first job).
d.
The later job is more likely to require training and will probably be a much harder job to
monitor. So, as efficiency wage theory suggests, your employer will be willing to pay a
lot more than your reservation wage for the later job, to ensure low turnover and low
shirking.
133
5.
6.
7.
a.
The computer network administrator has more bargaining power. She is much harder to
replace.
b.
The rate of unemployment is a key statistic. For example, when there are many
unemployed workers it becomes easier for firms to find replacements. This reduces the
bargaining power of workers.
c.
Given the constant returns to labor assumption, the real wage is always determined by the
price setting relation alone. Worker bargaining power has no effect.
a.
As the unemployment rate gets very low, it gets very difficult for firms to find workers to
hire. Therefore, worker bargaining power increases, and so does the wage.
b.
As the unemployment rate gets lower and lower, the wage gets higher and higher
(tending toward infinity as the unemployment rate goes to zero). So, there is some
unemployment rate at which the wage becomes so high that firms will not want to hire
more workers.
a.
employment
unemployment
labor force
unemployment rate
participation rate
EatIn
70
5
75
6.7%
75%
EatOut
95
5
100
5%
100%
Measured GDP is higher in EatOut.
b.
Measured employment, the measured labor force, the measured participation rate, and
measured GDP increasae in EatIn. Unemployment is unchanged, but the measured
unemployment rate falls.
c.
It is difficult to measure the value of work at home. In this case, you could attempt to
value food preparation at home by using the market price of food preparation in
restaurants (assuming that eating at home has the same value for a given meal as eating
out). This would be difficult in EatIn before there are restaurants. Likewise, you could
count workers involved in food preparation at home as employed.
d.
If food preparation at home is counted in GDP and workers involved in food preparation
at home are counted as employed, then the labor market statistics and measured GDP
would be the same in the two economies and the experiment in part (b) would have no
effect.
Explore Further
8.
a.
2/3=67%; (2/3)2= 44%; (2/3)6 = 9%
b.
2/3
c.
second month: (2/3)2=44%; sixth month: (2/3)6 = 9%
d.
Average proportion 27 weeks or more over 1990-1999= 16.1%
134
2000: 11.4%
2001: 11.8%
2002: 18.3%
9.
a-b.
c.
2003: 22.1%
2004: 21.8%
Long-term unemployed exit unemployment less frequently than the average.
Answers will depend on when the page is accessed.
The decline in unemployment does not equal the increase in employment, because the
labor force is not constant.
CHAPTER 7
Quick Check
1.
a.
b.
c.
d.
e.
f.
g.
True.
True.
False.
False.
True.
False.
False.
2.
a.
IS right, AD right, AS up, LM up, Y same, i up, P up
b.
IS left, AD left, AS down, LM down, Y same, i down, P down
3.
4.
Short run:
Medium run:
WS
up
up
PS
same
same
AS
up
up further
AD
same
same
LM
up
up further
Short run:
Medium run:
Y
down
down further
i
up
up further
P
up
up further
IS
same
same
a.
Money is neutral in the sense that the nominal money supply has no effect on output or
the interest rate in the medium run. Output returns to its natural level. The interest rate is
determined by the position of the IS curve and the natural level of output. Despite the
neutrality of money in the medium run, an increase in money can increase output and
reduce the interest rate in the short run. In particular, expansionary monetary policy can
be used to speed up the economy's return to the natural level of output when output is
low.
b.
In the medium run, investment and the interest rate both change with fiscal policy.
c.
False. Labor market policies, such as unemployment insurance, can affect the natural
level of output.
Dig Deeper
5.
a.
Open answer. Firms may be so pessimistic about sales that they do not want to borrow at
any interest rate.
135
6.
7.
8.
b.
The IS curve is vertical; the interest rate does not affect equilibrium output.
c.
No change.
d.
The AD curve is vertical; the price level does not affect equilibrium output.
e.
The increase in z reduces the natural level of output and shifts the AS curve up. Since the
AD curve is vertical, output does not change, but the price level increases. Note that
output is above its natural level.
f.
The AS curve shifts up forever, and the price level increases forever. Output does not
change; it remains above its natural level forever.
a.
The LM curve is flat.
b.
No effect.
c.
The AD curve is vertical. A change in P, which affects M/P, has no effect on the interest
rate or output.
d.
There is no effect on output in the short run or the medium run. Since the money stock
does not affect the interest rate, it does not affect output.
a.
The AD curve shifts left in the short run. Output and the price level fall in the short run.
In the medium run, the expected price level falls, and AS shifts right, returning the
economy to the original natural level of output, but at a lower price level.
b.
The unemployment rate rises in the short run, but returns to its original level (the natural
rate, which is unchanged) in the medium run.
c.
The Fed should increase the money supply, which shifts the AD curve right. A monetary
expansion of the proper size exactly offsets the effect of the decline in business
confidence on the AD curve. The net effect is that the AD curve does not move in the
short run or medium run, and neither does the AS curve.
d.
Under the policy option in part (c), output and the price level are higher in the short run.
In the medium run, output is the same in parts (a) and (c), but the price level is higher in
part (c).
e.
The unemployment rate is lower in the short run in part (c). In the medium run, the
unemployment rate is the same in parts (b) and (c).
a.
The AS curve shifts up in the short run and shifts up further in the medium run.
Output falls in the short run and falls further in the medium run. The price level rises in
the short run and rises further in the medium run.
b.
The unemployment rate rises in the short run and rises further in the medium run.
c.
The Fed could increase the money supply in the short run and shift the AD curve to the
right. The AS curve would shift up over time.
136
d.
Output and the price level are higher in the short run in part (c). Output is the same in the
medium run in parts (a) and (c), but the price level is higher in part (c).
e.
The unemployment rate in the short run is lower in part (c), but the same in the medium
run in parts (a) and (c).
9.
The Fed’s job is not so easy. It has to distinguish changes in the actual rate of unemployment from
changes in the natural rate of unemployment. The Fed can use monetary policy to keep the
unemployment rate near the natural rate, but it cannot affect the natural rate.
10.
a.
The unemployment rate rises in the short run and rises further in the medium run. The
real wage falls immediately to its new medium-run level.
b.
The unemployment rate falls in the short run but returns to the original natural rate in the
medium run. The real wage is unaffected. However, after tax income rises.
c.
In our model, the real wage depends only upon the markup. A fall in the markup
increases the real wage. Policy measures that improve product market competition – for
example, more vigorous anti-trust enforcement – could increase the real wage.
d.
The fall in income taxes tended to increase the after-tax real wage. The increase in oil
prices tended to reduce the after-tax real wage. Intuitively, the immediate effect of an oil
price increase is to reduce the real wage by increasing gas prices. Thus, the increase in
gas prices tends to absorb the extra after-tax income provided by the tax cut.
Explore Further
11.
a.
1959:IV – 1969:IV
1969:IV – 1979:IV
1979:IV – 1989:IV
1989:IV – 1999:IV
b.
The 70s, 80s, and 90s look remarkably similar. The 60s look most unusual.
52.9%
38.2%
35.1%
37.6%
Note, although the problem did not ask for the growth rates of per capita real GDP, the results
would be similar. The growth rates of per capita GDP are:
1959:IV – 1969:IV
1969:IV – 1979:IV
1979:IV – 1989:IV
1989:IV – 1999:IV
33.9%
24.4%
23.0%
21.8%
CHAPTER 8
Quick Check
1.
a.
b.
c.
d.
e.
True.
False.
False.
True.
False.
137
2.
3.
4.
f.
True.
a.
No. In the 1970s, we experienced high inflation and high unemployment. The
expectations-augmented Phillips curve is a relationship between inflation and
unemployment conditional on the natural rate and inflation expectations. Given inflation
expectations, increases in the natural rate (which result from adverse shocks to labor
market institutions—increases in z—or from increases in the markup—which encompass
oil shocks) lead to an increase in both the unemployment rate and the inflation rate. In
addition, increases in inflation expectations imply higher inflation for any level of
unemployment.
(Increases in inflation expectations also tend to increase the
unemployment rate in the short run from the supply side—think of an increase in the
expected price level, given last period’s price, in the AD-AS framework. However,
increases in inflation expectations may tend to increase short run output from the demand
side, because of the real interest rate effect. The real interest rate is introduced in Chapter
14.) In the 1970s, both the natural rate and expected inflation increased, so both
unemployment and inflation were relatively high.
b.
No. The expectations-augmented Phillips curve implies that maintaining a rate of
unemployment below the natural rate requires increasing (not simply high) inflation.
This is because inflation expectations continue to adjust to actual inflation.
a.
un=0.1/2 =5%
b.
πt =0.1-2*.03 = 4% every year beginning with year t.
c.
πet= 0 and πt=4% forever. Inflation expectations will be forever wrong. This is
unlikely.
d.
 might increase because people’s inflation expectations adapt to persistently positive
inflation. The increase in  has no effect on un.
e.
π5= π 4+.1-.06=4%+4%=8%
π6=12%; π7=16%
f.
Inflation expectations will again be forever wrong. This is unlikely.
a.
A higher cost of production means a higher markup of prices over wages. The markup
reflects all nonwage components of the price of a good.
b.
un=(0.08+0.1)/2; Thus, the natural rate of unemployment increases from 5% to 6% as μ
increases from 20% to 40%.
Dig Deeper
5.
a.
π t = π t-1 + 0.1 - 2ut = π t-1 + 2%=2%
π t = 2%; π t+1 = 4%; π t+2 = 6%; π t+3 = 8%.
b.
π t = 0.5 π t + 0.5 π t-1 + 0.1 - 2ut
or, π t = π t-1 + 4%
c.
π t = 4%; π t+1 = 8%; π t+2 = 12%; π t+3 = 16%
138
6.
7.
d.
As indexation increases, low unemployment leads to a larger increase in inflation over
time.
a.
Yes. The average rate of unemployment was lower in the 1990s. Indeed, even though
the unemployment rate was at a historical low, inflation rose very little.
b.
The natural rate of unemployment probably decreased.
a.
un=(+z)/; un = 6% if =1; un = 3% if =2
As  increases the natural rate of unemployment falls. Intuitively, higher wage flexibility
allows the economy to respond to any given set of institutions ( and z) with less
unemployment.
b.
un = 9% if =1; un = 4.5% if =2
In absolute terms, less wage flexibility (lower ) implies that a given supply shock will
lead to a greater increase in the natural rate of unemployment.
Explore Further
The equation that seems to fit well is πt – πt-1 = 6 – ut, which implies a natural rate of
6%.
8.
a-c.
9.
The relationships imply a lower natural rate in the more recent period.
CHAPTER 9
Quick Check
1.
a.
b.
c.
d.
e.
f.
g.
h.
i.
False.
True.
True.
False.
False.
True.
True.
True.
True.
2.
a.
The unemployment rate will increase by 1% per year when g=0.5%. Absent output
growth, productivity growth tends to increase the unemployment rate, since fewer
workers are required to produce a given quantity of goods. Absent output growth, labor
force growth also tends to increase the unemployment rate, since more workers are
competing for the same number of jobs. Therefore, unemployment will increase unless
the growth rate exceeds the sum of productivity growth and labor force growth.
b.
We want the unemployment rate to decrease by 0.5% per year for the next four years.
We need growth of 4.25% per year for each of the next four years.
c.
Okun’s law is likely to become: ut-ut-1=-0.4*(gyt-5%)
a.
un= 5%
3.
139
b.
Assume the economy has been at the natural rate of unemployment for two years (this
year and last year). Then, gyt = 3%; gmt = gyt + πt = 11%
c.
t-1:
t:
t+1:
t+2:
t+3:
4.
5.
π
8%
4%
4%
4%
4%
u
5%
9%
5%
5%
5%
gyt
3%
-7%
13%
3%
3%
gmt
11%
-3%
17%
7%
7%
a.
See text for full answer. Gradualism reduces need for large policy swings, with effects
that are difficult to predict, but immediate reduction may be more credible and encourage
rapid, favorable changes in inflation expectations. On the other hand, the staggering of
wage decisions suggests that, if the policy is credible, a gradual disinflation is the option
consistent with no change in the unemployment rate.
b.
Not clear. Based in Ball's evidence, probably fast disinflation, depending on the features
listed in part (c).
c.
Some important features: the degree of indexation, the nature of the wage-setting process,
and the initial rate of inflation.
a.
Inflation will start increasing.
b.
It should let unemployment increase to its new, higher, natural rate.
Dig Deeper
6.
7.
a.
sacrifice ratio=1
b.
πt = 11%; πt+1 = 10%; πt+2 = 9%; πt+3 = 8%; πt+4 = 7%
c.
10 years; sacrifice ratio=(10 point years of excess unemployment)/(10 percentage point
reduction in inflation)=1
d.
πt = 8.5%; πt+1 = 5.875%; πt+2 = 3.906%; πt+3 = 2.430%; πt+4 = 1.322%
Less than 5 years are required.
sacrifice ratio: 5/(12-1.322)=.468
The sacrifice ratio is lower because people are somewhat forward looking and
incorporate the target inflation rate into their expectations.
e.
The central bank can let the unemployment rate return to the natural rate beginnng at time
t+1. The ex post sacrifice ratio from this scenario = (1 point year of excess
unemployment)/(10 point reduction of inflation) = 0.1
f.
Take measures to enhance credibility.
a.
πt-πt-1= -(ut-.05)
ut- ut-1= -.4*(gmt-πt-.03)
140
b.
Assuming gm,t-1=13%,
t:
t+1:
t+2:
t+3:
t+4:
t+5:
t+6:
t+7:
t+8:
t+9:
t+10:
π
7.1%
3.1%
-0.7%
-3.2%
-4.1%
-3.5%
-2.1%
-0.5%
0.8%
1.5%
1.6%
πt-1= 10%, ut-1=5%, and gm=3% beginning in year t:
u
7.9%
9.1%
8.8%
7.5%
5.9%
4.4%
3.6%
3.4%
3.7%
4.3%
4.9%
c.
Inflation does not decline smoothly. In the early years, the large unemployment rates
(relative to the natural rate) reduce inflation to negative values. Since money growth = 3
% = normal output growth in this example, negative inflation drives real money growth
(and hence output growth) above the normal output growth rate, and unemployment falls.
Eventually, unemployment falls below the natural rate, inflation begins to increase again.
These cycles continue, with decreasing amplitude.
d.
u=5% and π=0% in the medium run.
Explore Further
8.
a.
Yes.
b.
The unemployment rate increased from 5,8% in June 2002 to 6.3% in June 2003.
c.
Although growth was positive, it was low – well below 3% for most of the period.
Growth was too low to prevent the unemployment rate.
d.
Employment fell by 0.7%.
e.
Yes.
f.
Productivity grew.
141