Question 1

Suppose a worker signs a contract containing a 7 percent nominal wage increase with inflation expected to be 5 percent. Inflation turns out to be 10 percent, but the contract also contains 50 percent COLA protection. The worker's real wage under the contract
A) falls by 3.0 percent.
B) rises by 0.5 percent.
C) rises by 2.0 percent.
D) rises by 1.0 percent.
E) falls by 0.5 percent.

Accepted Answer

The answer of Suppose a worker signs a contract containing...

Question 2

In New Keynesian macroeconomics, when marginal costs are too sticky to change in proportion to nominal aggregate demand, prices ________ and so menu costs ________ needed to explain business cycles.
A) are also sticky, are
B) are also sticky, are not
C) are still perfectly flexible, are
D) are still perfectly flexible, are not

Accepted Answer

In New Keynesian macroeconomics, it is assumed that prices are sticky in the short run, which means they do not immediately adjust to changes in demand. This is due to the presence of menu costs, which are the costs incurred by firms when they change their prices. However, when marginal costs are too sticky to adjust in proportion to nominal aggregate demand, it becomes difficult for firms to adjust their prices even with the menu costs. Therefore, prices remain sticky and menu costs are not sufficient to explain business cycles.

Question 3

The flaw of the Friedman model of the business cycle is that it
A) assumes away output fluctuations.
B) assumes complete wage rigidity.
C) assumes unrealistic fooling of workers.
D) requires procyclical wage movements and continuous labor market equilibrium.

Accepted Answer

The Friedman model of the business cycle, particularly in its incorporation of the "natural rate of unemployment" and expectations-augmented Phillips Curve, is often criticized for assuming that workers can be systematically fooled by inflation into supplying more labor than they otherwise would, which many find to be an unrealistic assumption over the long term.

Question 4

Employing the New Keynesian concepts of "macroeconomic externality" and "coordination failure": if nominal aggregate demand and marginal cost fall by the same proportion, society ________ afford to compensate firms for the profit they lose when they ________.
A) can, bear the menu costs of changing prices
B) can, hold prices constant
C) cannot, bear the menu costs of changing prices
D) cannot, hold prices constant

Accepted Answer

The answer of Employing the New Keynesian concepts of "macroeconomic...

Question 5

Crucial assertions in the menu-cost literature are that those costs ________ be large for them to have an effect on firms' pricing, while potential total welfare losses ________ menu costs that have been avoided.
A) need not, may be several times larger
B) need not, are generally much less than
C) must, may be several times larger
D) must, are generally much less than

Accepted Answer

Menu costs need not be large to affect pricing because even small costs can deter price changes. However, the potential total welfare losses from not changing prices can be much larger than the menu costs themselves.

Question 6

Nonunion wages should be modeled as
A) sticky, because they imitate union wages rather closely.
B) sticky, because their contracts cannot contain COLA clauses.
C) perfectly flexible, because wage contracts are illegal outside of unions.
D) perfectly flexible, because workers willing to take the risks of full wage flexibility are precisely those workers who have rejected unionization.

Accepted Answer

Nonunion wages tend to be sticky because they are influenced by union wages, which are often determined through collective bargaining agreements that set wages for an entire industry or occupation. Nonunion employers may offer similar wages and benefits in order to compete for workers, resulting in the stickiness of nonunion wages.

Question 7

In Figure 17-4, below, initial demand, marginal cost, and marginal revenue curves (none of them shown) caused the firm to produce the profit-maximizing quantity YS1U1B10S1U1B0 at a price of P0. Now the demand and marginal cost curves have moved to those shown, with the marginal revenue curve running through point L.
Figure 17-4 
-If the firm in the figure above maintains its set price of P0, rather than dropping price to P1, the welfare loss to society due to this decision is
A) J + K.
B) K - G.
C) G + H.
D) H + K.
E) F + G + H.

Accepted Answer

If the firm maintains its price at P0, it will continue to produce Y₀ quantity, as it is still the profit-maximizing point. However, the new demand and marginal cost curves result in a new marginal revenue curve that runs through point L. At quantity YL1U1B20L, the marginal cost equals the marginal revenue. However, at quantity Y₀, the marginal cost is lower than the marginal revenue. This means that there is a deadweight loss to society due to the firm not producing enough at the given price of P0. The areas of deadweight loss are H and K. Therefore, the welfare loss to society due to the firm's decision is H + K. The correct answer is D.

Question 8

In Figure 17-4, below, initial demand, marginal cost, and marginal revenue curves (none of them shown) caused the firm to produce the profit-maximizing quantity YS1U1B10S1U1B0 at a price of P0. Now the demand and marginal cost curves have moved to those shown, with the marginal revenue curve running through point L.
Figure 17-4 
-If the firm in the figure above maintains its set price of P0, rather than dropping price to P1, it must be facing a "menu cost" of adjusting its price that exceeds
A) K - G.
B) K + G.
C) G - K.
D) J.
E) K.

Accepted Answer

The firm will only maintain its price at P0 if the cost of changing the price (menu cost) is greater than the loss in revenue from not changing the price, which is represented by the area K - G.

Question 9

Suppose a worker signs a contract containing an 8 percent nominal wage increase with inflation expected to be 3 percent. Inflation turns out to be 6 percent, but the contract also contains 60 percent COLA protection. The worker's real wage under the contract
A) falls by 1.2 percent.
B) falls by 2.4 percent.
C) rises by 3.8 percent.
D) rises by 3.0 percent.
E) rises by 1.8 percent.

Accepted Answer

The answer of Suppose a worker signs a contract containing...

Question 10

A central concept of New Keynesian macroeconomics is that in setting prices and wages, self-interested firms and workers are acting
A) irrationally, since their self-interest is badly damaged by the ensuing business cycles.
B) irrationally, since this imposes business cycles on everyone not part of their arrangements.
C) rationally, since they do not bear a fully offsetting cost of business cycles.
D) rationally, since the total welfare loss of business cycles must be small enough to justify the price and wage setting.

Accepted Answer

According to New Keynesian macroeconomics, firms and workers are acting rationally because they do not bear a fully offsetting cost of business cycles. This means that while business cycles may have negative effects on the economy, the costs are not fully borne by those setting prices and wages. Therefore, they have an incentive to set prices and wages based on their own self-interest, even if it may contribute to macroeconomic instability.

Question 11

A transaction between A and B benefits both parties by 50, but imposes a cost on C of 20. C has the right to prevent the transaction. A "coordination failure" in this situation
A) is the cost imposed on C.
B) is the ability of C to prevent a transaction that still has a net overall gain of 80.
C) would occur if A and B do not compensate C by 20 or more to allow the transaction.
D) is that the cost to C is not 100.

Accepted Answer

The coordination failure in this situation would occur if A and B do not compensate C by 20 or more to allow the transaction. This is because the transaction has a net overall gain of 80, which is beneficial for both A and B, but the cost of 20 to C creates a negative externality. In order to overcome this coordination failure, A and B would need to provide compensation to C that is greater than or equal to the cost imposed on them. This would help to ensure that all parties are better off as a result of the transaction.

Question 12

After a drop in nominal aggregate demand, if menu costs prevent firms from reducing prices, this is considered ________ act by firms ________ a "macroeconomic externality."
A) a rational, because it produces
B) a rational, that happens to produce
C) an irrational, because it produces
D) an irrational, that happens to produce

Accepted Answer

The answer of After a drop in nominal aggregate demand,...

Question 13

The flaw of the Classical model of the business cycle is that it
A) assumes away output fluctuations.
B) assumes complete wage rigidity.
C) assumes unrealistic fooling of workers.
D) requires procyclical wage movements and continuous labor market equilibrium.

Accepted Answer

The Classical model of the business cycle is criticized for assuming away output fluctuations, essentially suggesting that the economy is always at or near full employment and that markets, including the labor market, clear through price and wage adjustments. This overlooks the possibility of significant output fluctuations and the reality of economic cycles.

Question 14

The flaw of the Real Business Cycle model is that it
A) assumes away output fluctuations.
B) assumes complete wage rigidity.
C) assumes unrealistic fooling of workers.
D) requires procyclical wage movements and continuous labor market equilibrium.

Accepted Answer

The Real Business Cycle (RBC) model assumes that the labor market is always in equilibrium and that wages move in a procyclical manner, meaning they increase during economic expansions and decrease during recessions. This assumption is often criticized for not accurately reflecting real-world labor market dynamics, where wages can be sticky and labor markets do not always clear instantly.

Question 15

The flaw of the original Keynesian model of the business cycle is that it
A) assumes away output fluctuations.
B) assumes complete wage rigidity.
C) assumes unrealistic fooling of workers.
D) requires procyclical wage movements and continuous labor market equilibrium.

Accepted Answer

The flaw of the original Keynesian model of the business cycle is that it assumes complete wage rigidity, which means that wages do not adjust in response to changes in demand or supply in the labor market. This assumption is unrealistic and does not reflect the reality of the labor market.

Question 16

In Figure 17-4, below, initial demand, marginal cost, and marginal revenue curves (none of them shown) caused the firm to produce the profit-maximizing quantity YS1U1B10S1U1B0 at a price of P0. Now the demand and marginal cost curves have moved to those shown, with the marginal revenue curve running through point L.
Figure 17-4 
-If the firm in the figure above maintains its set price of P0, rather than dropping price to P1, the loss of consumer surplus due to this decision is
A) J + K.
B) K - G.
C) G + H.
D) H + K.

Accepted Answer

The loss of consumer surplus is represented by the area between the demand curve and the price line that consumers are willing to pay but do not due to the higher price. This area is G + H.

Question 17

Suppose that nominal aggregate demand falls by 4 percent, and at the same time every marginal cost also falls by 4 percent. The importance of menu cost theory is that in this situation the price level ________, meaning that a recession ________.
A) must fall by 4 percent as well, does not occur
B) must fall by 4 percent as well, must occur
C) still might not fall, may not occur
D) still might not fall, may occur

Accepted Answer

The answer of Suppose that nominal aggregate demand falls by...

Question 18

The central idea distinguishing the "efficiency wage model" is that the wage paid by Firm A relative to the wages at other firms helps determine
A) Firm A's demand for labor.
B) the amount of labor Firm A can hire.
C) the productivity of Firm A's workers.
D) Firm A's markup fraction.

Accepted Answer

The central idea of the efficiency wage model is that paying workers a wage above the market rate can increase their productivity and efficiency, leading to cost savings for the firm. Thus, the relative wage paid by Firm A compared to other firms can impact the productivity of its workers, and ultimately the firm's profits. Therefore, the correct answer is C, the productivity of Firm A's workers.

Question 19

In Figure 17-4, below, initial demand, marginal cost, and marginal revenue curves (none of them shown) caused the firm to produce the profit-maximizing quantity YS1U1B10S1U1B0 at a price of P0. Now the demand and marginal cost curves have moved to those shown, with the marginal revenue curve running through point L.
Figure 17-4 
-If the firm in the figure above maintains its set price of P0, rather than dropping price to P1, this reduces its profit by
A) K - G.
B) K + G.
C) G - K.
D) G + H.
E) G.

Accepted Answer

The answer of In Figure 17-4, below, initial demand, marginal...

Question 20

About what percentage of the U.S. labor force works under union wage contracts?
A) 50 percent
B) 35 percent
C) 25 percent
D) 10 percent

Accepted Answer

According to the Bureau of Labor Statistics, in 2020, only 10.8 percent of U.S. workers were members of labor unions, and only 7.1 percent of private sector workers were union members. Therefore, it can be assumed that only a small percentage of the U.S. labor force works under union wage contracts.

Quiz 17: New Classical Macro Confronts New Keynesian Macro

Suppose a worker signs a contract containing a 7 percent nominal wage increase with inflation expected to be 5 percent. Inflation turns out to be 10 percent, but the contract also contains 50 percent COLA protection. The worker's real wage under the contract

In New Keynesian macroeconomics, when marginal costs are too sticky to change in proportion to nominal aggregate demand, prices and so menu costs needed to explain business cycles.

The flaw of the Friedman model of the business cycle is that it

Employing the New Keynesian concepts of "macroeconomic externality" and "coordination failure": if nominal aggregate demand and marginal cost fall by the same proportion, society afford to compensate firms for the profit they lose when they .

Crucial assertions in the menu-cost literature are that those costs be large for them to have an effect on firms' pricing, while potential total welfare losses menu costs that have been avoided.

Nonunion wages should be modeled as

Suppose a worker signs a contract containing an 8 percent nominal wage increase with inflation expected to be 3 percent. Inflation turns out to be 6 percent, but the contract also contains 60 percent COLA protection. The worker's real wage under the contract

A central concept of New Keynesian macroeconomics is that in setting prices and wages, self-interested firms and workers are acting

A transaction between A and B benefits both parties by 50, but imposes a cost on C of 20. C has the right to prevent the transaction. A "coordination failure" in this situation

After a drop in nominal aggregate demand, if menu costs prevent firms from reducing prices, this is considered act by firms a "macroeconomic externality."

The flaw of the Classical model of the business cycle is that it

The flaw of the Real Business Cycle model is that it

The flaw of the original Keynesian model of the business cycle is that it

Suppose that nominal aggregate demand falls by 4 percent, and at the same time every marginal cost also falls by 4 percent. The importance of menu cost theory is that in this situation the price level , meaning that a recession .

The central idea distinguishing the "efficiency wage model" is that the wage paid by Firm A relative to the wages at other firms helps determine

About what percentage of the U.S. labor force works under union wage contracts?