1) The processes a firm uses to turn inputs into outputs of goods and services are the firm's
A) production function.
B) technology.
C) total factor productivity.
D) manufacturing ideology.
Answer: B
2) In the aggregate production function, Y represents real GDP, K represents the capital stock, L represents
the quantity of labor, and A represents an index of efficiency. Which of the following equations represents
the aggregate production function?
A) Y = (K × L) / A
B) Y × A = (K × L)
C) Y = AF(K, L)
D) Y = (K × L) = A /FY
Answer: C
3) Which of the following equations best represents the concept of constant returns to scale?
A) 3Y = AF(3K, 3L)
B) 2Y = 2AF(2K,2 L)
C) 1/4Y = (AF / 4 )(4K, 4L)
D) 5Y = [AF(K, L)] / 5
Answer: A
4) Which of the following equations best represents a Cobb-Douglas production function?
A) Y = AK1L1
B) Y = AK3/4L1/4
C) Y = AK1/3L3
D) Y = AK2/3L3/2
Answer: B
5) All else equal, in an economy with an upward-sloping production function, as an economy accumulates
more capital goods,
A) the labor supply must increase.
B) real GDP increases.
C) the labor supply must decrease.
D) the marginal product of capital will increase.
Answer: B
6) The marginal product of capital is always ________ and it ________ as the capital stock increases.
A) positive; increases
B) positive; decreases
C) negative; increases
D) negative; decreases
Answer: B
7) Suppose that the production function for the economy is Y = AK1/4L3/4. Assume that real GDP is $8,000
billion, capital stock is $32,000 billion, and the labor supply is 120 million (or 0.120 billion) workers. Total
factor productivity for this economy is
A) 16.50
B) 1,016.52
C) 2,083.33
D) 2,933.65
Answer: D
8) If the marginal product of labor is less than the nominal wage divided by the price of output, a firm that
wishes to maximize profits will
A) hire more labor.
B) lay off workers.
C) maintain its current level of workers.
D) raise the real wage.
Answer: B
9) A firm that wishes to maximize profits will continue to purchase capital goods until the
A) nominal rental price of capital = MPK.
B) real rental price of capital = MPK.
C) nominal rental price of capital = the real rental price of capital.
D) nominal rental price of capital = the price level.
Answer: B
10) Suppose that the production function for the economy is Y = AK0.5L0.5. If the capital stock = 40,000,
the quantity of labor = 10,000, and the efficiency index = 3, the equilibrium real rental price of capital is
A) $0.33.
B) $0.75.
C) $1.00.
D) $2.22.
Answer: B
11) Along the per worker production function, as the capital-labor ratio ________, increases in output per
worker become progressively ________.
A) increases; larger
B) increases; smaller
C) decreases; larger
D) decreases; smaller
Answer: B
12) Suppose y = Ak1/4, the capital-labor ratio is $40,000 per worker, the level of total factor productivity is
800, 70% of the population works, and there are 70 million workers. Real GDP per capita is
A) $3,500.00.
B) $5,543.72.
C) $7919.60.
D) $9,899.50.
Answer: C
13) Assuming that total factor productivity is constant, describe the effect of an increase in the capital-labor
ratio on the per worker production function. What happens to the marginal product of labor, the marginal
product of capital, and real GDP per capita?
Answer: The economy will move up along the per worker production function. The marginal product of
labor will increase at a decreasing rate, the marginal product of capital will decrease, and real GDP per capita
will increase.
14) What two factors determine labor productivity? Explain which of the two is more important.
Answer: The capital-labor ratio and total factor productivity determine labor productivity. Total factor
productivity is more important because the production function displays diminishing marginal returns for the
capital-labor ratio, but diminishing marginal returns do not apply to total factor productivity.
15) Countries with a low standard of living have low levels of total factor productivity. List 5 reasons that
account for the low levels of total factor productivity.
Answer:
1. lack of investment in research and development
2. low quality of labor from low investment in education
3. government institutions that do not protect private property and that discourage investment
4. geography that makes trade difficult or makes diseases more prevalent
5. a lack of financial institutions that allow funds to flow from firms with profitable investment projects
16) Assume the capital-labor ratio remains constant. If investment increases at a constant rate, real GDP per
worker will increase ________, and if total factor productivity increases at a constant rate, real GDP per
worker will increase ________.
A) at an increasing rate; at an increasing rate
B) at a constant rate; at an increasing rate
C) at a constant rate; at a decreasing rate
D) at a decreasing rate; at a constant rate
Answer: D
17) In the steady state in the Solow growth model, the economy is in equilibrium with the capital-labor ratio
and real GDP per worker ________, and with capital, labor, and real GDP ________.
A) constant; constant
B) growing; constant
C) constant; growing
D) growing; growing
Answer: C
18) In the Solow growth model, a change in the capital-labor ratio is equal to
A) (saving - investment).
B) saving + depreciation).
C) (investment - depreciation).
D) (capital stock - labor force).
Answer: C
19) In the Solow growth model, if the level of investment is less than depreciation at the initial capital-labor
ratio , then △k is ________ and the capital-labor ratio ________ toward the steady-state capital-labor ratio.
A) greater than zero; increases
B) greater than zero; decreases
C) less than zero; increases
D) less than zero; decreases
Answer: D
20) Suppose y = k1/2, total factor productivity is constant and equal to 1, s = 0.40, and d = 0.10. When the
economy reaches the steady state, the capital-labor ratio is ________ of capital per worker.
A) $2
B) $4
C) $8
D) $16
Answer: D
21) Suppose y = k1/2, total factor productivity is constant and equal to 1, s = 0.40, and d = 0.10. When the
economy reaches the steady state, consumption per worker is ________.
A) $1.20
B) $2.40
C) $4.80
D) $13.60
Answer: B
22) Suppose y = k1/4, total factor productivity is constant and equal to 1, s = 0.40, and d = 0.05.
a. Find the steady-state capital––labor ratio for this economy.
b. Find the steady-state real GDP per worker for this economy.
c. Find the steady-state level of investment per worker for this economy.
d. Find the steady-state level of consumption per worker for this economy.
Answer:
a. The steady-state capital - labor ratio: (k* / k*1/4) = 0.40 / 0.05. k*3/4 = 8. k* = 84/3. k* = $16.
b. The steady-state real GDP per worker: y = k1/4 = 161/4 = $2.
c. The steady-state level of investment per worker: i = 0.40(2) = $0.80.
d. The steady-state level of consumption per worker: c = 0.60(2) = $1.20.
23) If the capital-labor ratio equals 1.5 in the steady state, depreciation equals 20, and dilution equals 10,
break-even investment equals
A) 15.
B) 20.
C) 30.
D) 45.
Answer: D
24) If the saving rate decreases, break-even investment will be ________ than investment, and the capitallabor ratio will ________.
A) greater; increases
B) greater; decreases
C) less; increases
D) less; decreases
Answer: B
25) The Solow growth model predicts that a lower labor force growth rate will lead to
A) a decreased steady state and higher break-even investment.
B) higher productivity and a higher standard of living.
C) a lower saving rate and decreased investment.
D) a higher rate of dilution and lower break-even investment.
Answer: B
26) Which expression best represents the break-even level of investment when incorporating laboraugmenting technological change into the Solow growth model?
A) (d + n + g)k
B) (d + n)k
C) (d + n ) / (k + g)
D) (d + n + k) / (gk)
Answer: A
27) Changes in the saving rate, labor-force growth rate, and depreciation rate will ________ the steady-state
level of real GDP per capita and will ________ the steady-state growth rate.
A) affect; affect
B) affect; not affect
C) not affect; affect
D) not affect; not affect
Answer: B
28) Balanced growth occurs when
A) the economy is in steady state.
B) the growth rates for the capital-labor ratio and real GDP per worker are the same.
C) total factor productivity and capital accumulation each account for the same amount of growth in labor
productivity.
D) nations converge to the same level of real GDP per worker from equal increases in total factor
productivity.
Answer: B
29) Balanced growth paths can differ across countries due to differences in saving rates, labor force growth
rates, and the rates of labor-augmenting technological change. These differences are likely to result in
differences in ________, a common measure of the standard of living.
A) happiness
B) life expectancy
C) income distribution
D) real GDP per capita
Answer: D
30) Endogenous growth theory tries to explain why
A) the growth rate of technological change varies across countries.
B) capital is not subject to diminishing marginal returns.
C) total factor productivity is the only determinant of labor productivity.
D) balanced growth occurs in all economies.
Answer: A
31) and 32) In the Solow growth model, the growth rate of real GDP per worker depends on the ________,
and in the AK growth model, the growth rate of real GDP per worker depends on the ________.
A) rate of depreciation; rate of dilution
B) investment growth; rate of population growth
C) growth rate of the capital stock; growth rate of the labor force
D) rate of labor-augmenting technological change; national saving rate
Answer: D
33) What effect would each of the following government actions have on the steady-state growth rate of the
standard of living?
a. a decrease in income tax rates
b. a doubling of the capital gains tax
c. a growing budget deficit
d. an increase in funding for research and development at public universities
Answer:
a. A decrease in income tax rates will increase the amount of household saving and should increase the
steady-state growth rate.
b. A doubling of the capital gains tax should decreases the incentive for firms to accumulate capital and
should decrease the steady-state growth rate.
c. A growing budget deficit should decrease the national saving rate and the steady-state growth rate.
d. An increase in funding for R&D for public universities will increase the rate of technological change and
should increase the steady-state growth rate.
34) A reason why a firm's demand for labor curve slopes downward is that, holding everything else constant,
A) the extra cost of hiring additional units of labor increases as a firm hires more units of labor.
B) as more labor is hired, labor's marginal product falls due to diminishing marginal returns.
C) the firm's demand curve for the product produced by the labor is downward sloping.
D) each additional unit of labor hired is less efficient than previously hired units.
Answer: B
35) Changes in all of the following will shift the demand curve for labor except
A) the real wage rate.
B) the quantity of capital.
C) the technology of production.
D) the skill level of workers.
Answer: A
36) The substitution effect of a real wage increase is observed when
A) the higher wage causes workers to take more leisure and work more hours.
B) the higher wage causes workers to take more leisure and work fewer hours.
C) leisure's higher opportunity cost causes workers to take less leisure and work more hours.
D) leisure's higher opportunity cost causes workers to take more leisure and work fewer hours.
Answer: C
37) The income effect of a real wage increase is observed when
A) the higher wage causes workers to take more leisure and work fewer hours.
B) the higher wage causes workers to take less leisure and work more hours.
C) leisure's higher opportunity cost causes workers to take less leisure and work more hours.
D) leisure's higher opportunity cost causes workers to take more leisure and work more hours.
Answer: A
38) If the real wage is above the equilibrium real wage, there would be a ________ of workers and the real
wage would ________.
A) surplus; decline
B) surplus; rise
C) shortage; decline
D) shortage; rise
Answer: A
39) What is the substitution effect of a wage increase? What is the income effect of a wage increase? Explain
under what conditions the labor supply curve will be upward sloping and when it will be downward sloping.
Answer: The substitution effect refers to the fact that an increase in wages raises the opportunity cost of
leisure and causes workers to devote more time to working and less time to leisure activities. The income
effect refers to the fact that an increase in wages increases workers' purchasing power and causes an increase
in the quantity demanded of leisure, causing a reduction the quantity of labor supplied. The labor supply
curve will be upward sloping when the substitution effect is greater than the income effect, so an increase in
the real wage will increase the quantity of labor supplied, and will be downward sloping if the income effect
is greater than the substitution effect, so an increase in the real wage will decrease the quantity of labor
supplied.
40) Explain what will happen to the equilibrium real wage and quantity of labor for each of the following
scenarios, and use a graph of the aggregate labor market to show the changes.
a. The government decreases income tax rates.
b. The skill level of workers increases.
c. A hurricane destroys a large portion of the capital stock.
d. Workers increase their preference of labor over leisure.
e. A technological change occurs that increases the productivity of all workers, and at the same time the
government increases income tax rates.
f. The overall skill level of workers decreases, and at the same time household wealth increases.
Answer:
a. A decrease in income tax rates will increase the supply of labor, shifting the labor supply curve to the right,
which decreases the equilibrium wage and increases the quantity of labor. On the graph, this is represented
by a shift from S1 to S2,
b. An increase in the skill level of workers will increase the demand for labor, shifting the labor demand
curve to the right, which increases the equilibrium wage and increases the quantity of labor. On the graph,
this is represented by a shift from D1 to D2.
c. Destruction of the capital stock will decrease the demand for labor, shifting the labor demand curve to the
left, which decreases the equilibrium wage and decreases the quantity of labor. On the graph, this is
represented by a shift from D2 to D1.
d. An increase in workers' preference of labor over leisure will increase the supply of labor, shifting the labor
supply curve to the right, which decreases the equilibrium wage and increases the quantity of labor. On the
graph, this is represented by a shift from S1 to S2.
e. Increased worker productivity will increase the demand for labor, shifting the labor demand curve to the
right, which increases the equilibrium wage and increases the quantity of labor. On the graph, this is
represented by a shift from D1 to D2
An increase in income tax rates will decrease the supply of labor, shifting the labor supply curve to the left,
which increases the equilibrium wage and decreases the quantity of labor. On the graph, this is represented
by a shift from S2 to S1.
When these two events occur at the same time, we know for sure that the equilibrium real wage will
increase. The new equilibrium quantity of labor may increase, decrease, or stay the same, depending on the
magnitudes of the changes in demand and supply.
f. Decreased skill level of workers will decrease the demand for labor, shifting the labor demand curve to the
left, which decreases the equilibrium wage and decreases the quantity of labor. On the graph, this is
represented by a shift from D2 to D1
An increase in household wealth will decrease the supply of labor, shifting the labor supply curve to the left,
which increases the equilibrium wage and decreases the quantity of labor. On the graph, this is represented
by a shift from S2 to S1.
When these two events occur at the same time, we know for sure that the equilibrium quantity of labor will
decrease. The new equilibrium real wage may increase, decrease, or stay the same, depending on the
magnitudes of the changes in demand and supply.
41) Because it takes time for workers to search for a job and for firms to search for new employees, there
will always be some workers who are
A) frictionally unemployed.
B) structurally unemployed.
C) cyclically unemployed.
D) seasonally unemployed.
Answer: A
42) ________ unemployment is short term, but ________ unemployment can last for longer periods because
workers need time to acquire new skills.
A) Cyclical; frictional
B) Structural; seasonal
C) Seasonal; frictional
D) Frictional; structural
Answer: D
43) Daniel was just laid off from his teaching job at the local high school due to state budget cuts resulting
from the reduction in tax revenue during the recent economic downturn. Daniel would best be categorized as
A) frictionally unemployed.
B) structurally unemployed.
C) cyclically unemployed.
D) seasonally unemployed.
Answer: C
44) The economy is considered to be at full employment when
A) the frictional unemployment rate is zero.
B) the structural unemployment rate is zero.
C) the cyclical unemployment rate is zero.
D) the unemployment rate is zero.
Answer: C
45) Explain what causes the three types of unemployment. What advice for finding a job would be
appropriate for someone in each type of unemployment?
Answer: Frictional unemployment is the unemployment that arises from the process of matching workers
with jobs. These workers are qualified and just need to search for a job. The advice for finding a job would
be to keep searching because there are jobs available for which they are qualified.
Structural unemployment is unemployment arising from a persistent mismatch between the skills and
characteristics of workers and the requirements of the available jobs. The advice for finding a job would be
to retrain so that they can match up with the requirements of current jobs.
Cyclical unemployment is unemployment caused by a recession. The advice for finding a job would be to
continue searching for a job, but realize that there are fewer jobs available than the number of applicants.
The cyclically unemployed person could perhaps get a temporary job until the economy improves, or
perhaps consider continuing his or her education while the recession lasts.
46) If the rate of job finding equals 7%, and the rate of job separation equals 1%, then the natural rate of
unemployment is
A) 7%.
B) 8.75%.
C) 12.5%.
D) 14.3%.
Answer: C
47) and 48) If the rate of job finding equals 19%, and the natural rate of unemployment is 5%, then the rate
of job separation equals
A) 1%.
B) 5.26%.
C) 20.8%.
D) 26.3%.
Answer: A
49) If firms pay efficiency wages, they pay wages that
A) are mandated by the government.
B) will eventually lower the unemployment rate.
C) motivate workers to increase their productivity.
D) are lower than average to ensure maximum profit.
Answer: C
50) Because labor unions contribute to keeping real wages ________ their equilibrium levels, higher
unionization rates will tend to contribute to ________ unemployment rates.
A) above; higher
B) above; lower
C) below; higher
D) below; lower
Answer: A
51) Demand and supply of labor are given by:
LD = 250 - 4w
LS = 50 + w
where w is the real wage and LD and LS are the quantities of labor demanded and labor supplied,
respectively.
a. What are the equilibrium wage and quantity of employment?
b. If the government imposed a minimum wage of $45, what would be the new quantities of labor and
demanded and supplied?
c. How many people would lose their jobs because of the minimum wage, and how many people are now
unemployed?
Answer:
a. Equilibrium is: 250 - 4w = 50 + w; 200 = 5w. w = $40 = equilibrium wage.
Quantity of employment = 250 - (4 × 40) = 90 (or 50 + 40 = 90).
b. If the government imposed a minimum wage of $45, the quantity of labor demanded would be: 250 - (4 ×
45) = 250 - 180 = 70. The quantity of labor supplied would be: 50 + 45 = 95.
c. Before the minimum wage, 90 people were employed. With the minimum wage, 70 people are employed,
so 20 people would lose their jobs.
With the minimum wage, the quantity of labor supplied is 95 and the quantity of labor demanded is 70, so 25
are now unemployed.
52) Keynesian economics refers to the perspective that the business cycle represents
A) equilibrium.
B) disequilibrium.
C) long-run macroeconomic fluctuations.
D) short-run macroeconomic stability.
Answer: B
53) Classical economics refers to the perspective that the business cycle can be explained
A) using equilibrium analysis.
B) using disequilibrium analysis.
C) by long-run macroeconomic fluctuations.
D) by short-run macroeconomic instability.
Answer: A
54) From the Keynesian perspective, an increase in cyclical unemployment during a recession represents
A) an equivalent increase in the natural rate of unemployment.
B) a roughly equal mix of voluntary and involuntary unemployment.
C) involuntary unemployment.
D) a decrease in the number of discouraged workers in an economy.
Answer: C
55) One reason why an economy may not smoothly adjust to a macroeconomic shock is that
A) prices are flexible in the long run.
B) prices are sticky in the short run.
C) wages are sticky in the long run.
D) prices and wages are sticky in the long run.
Answer: B
56) Suppose that the demand for labor decreases due to an economic downturn, and union workers are in the
first year of a 3-year labor contract. With respect to these union laborers, the economic downturn will most
likely ________ the nominal wage and ________ the quantity of labor hired.
A) decrease; not change
B) decrease; decrease
C) not change; decrease
D) not change; not change
Answer: C
57) What is the business cycle and why does it occur?
Answer: The business cycle is alternating periods of economic expansions and recessions. The business
cycle occurs due to the combined effects of economic shocks and nominal price and wage stickiness. Shocks
alter the consumption and investment decisions of households and firms, given current nominal prices and
wages. With sticky prices and wages, shocks cause output to fluctuate, altering real GDP.
58) On average, expansions in the United States have become ________, and recessions have become
________ since 1950.
A) longer; longer
B) longer; shorter
C) shorter; longer
D) shorter; shorter
Answer: B
59) The economy is in an expansion when it is
A) moving from a peak to a trough.
B) moving from a trough to a peak.
C) at its peak.
D) at its trough.
Answer: B
60) If potential GDP for the first quarter of 2013 = $75.8 billion, and real GDP for the first quarter of 2013 =
$80.3 billion, then the output gap was
A) -5.9%.
B) -5.6%.
C) 5.6%.
D) 5.9%.
Answer: D
61) Okun's law summarizes the relationship between
A) unemployment and inflation.
B) potential GDP and real GDP.
C) potential GDP and the deviation from potential GDP.
D) the output gap and the cyclical rate of unemployment.
Answer: D
62) Assume that for the second quarter of 2012, actual real GDP was $125.5 billion and potential real GDP
was $142.7 billion. According to Okun's law, the cyclical unemployment rate during the second quarter of
2012 was
A) 5.7%.
B) 6.0%.
C) 6.9%.
D) 7.4%.
Answer: B
63) All of the following are typically considered procyclical variables except
A) the inflation rate.
B) investment expenditures.
C) the unemployment rate.
D) expenditures on durable goods.
Answer: C
64) If a variable moves in the opposite direction from real GDP and other measures of aggregate economic
activity, it is a ________ variable.
A) procyclical
B) countercyclical
C) coincidental
D) recessionary
Answer: B
65) Suppose that in 2013,potential GDP in the nation of Bologna is $150,000, real GDP is $138,000, and
potential GDP grows at a rate of 5% per year.
a. Calculate potential GDP for the next 3 years.
b. If real GDP is $143,000 in 2014, what is the output gap?
c. If real GDP is $160,000 in 2015, what is the output gap?
d. If real GDP is $182,000 in 2016, what is the output gap?
Answer:
a. Potential GDP in 2014 = $150,000 × 1.05 = $157,500.
Potential GDP in 2015 = $157,500 × 1.05 = $165,375.
Potential GDP in 2016 = $165,375 × 1.05 = $173,644.
b. Output gap in 2014 = ($143,000 - $157,500) / $157,500 = -9.2%.
c. Output gap in 2015 = ($160,000 - $165,375) / $165,375 = -3.3%.
d. Output gap in 2016 = ($182,000 - $173,644) / $173,644 = +4.8%.
66) Suppose for every dollar change in household wealth, consumption expenditures change by $0.10. If real
household wealth increases by $200 billion and potential GDP is $950 billion, what is the total change in
output relative to potential for:
a. the first year, if the multiplier effect for the first year after an expenditure shock is 1.7?
b. the second year, if the multiplier effect for the second year after an expenditure shock is 1.3?
c. the third year, if the multiplier effect for the third year after an expenditure shock is 0.9?
Answer: The change in total consumption expenditures is ($200 billion × 0.10) = $20 billion.
The initial change in consumption represents ($20 billion / $950 billion) = 2.1% of potential GDP.
a. Total change in output relative to potential for the first year = (1.7 × 2.1) = 3.57%.
b. Total change in output relative to potential for the second year = (1.3 × 2.1) = 2.73%.
c. Total change in output relative to potential for the third year = (0.9 × 2.1) = 1.89%.