Case / Fair - Chapter 20 - 1-2-8-9-12-13

Chapter 20 - 1-2-8-9-12-13

This is a guidance answer ... your actual answer during the exam should be longer than this answer ...

1.     Inflation is an increase in the overall price level. In the simple economy described in the question, you might be tempted to look at the average price of the three goods to see how the overall price level has changed. On January 1, 2012 the average price was ($2.50 + $3.00 + 1.50)/3 = $2.33, whereas at the end of the year it was ($5.00 + $2.00 + 1.50)/3 = $2.83. From this you can conclude that on average prices are higher. This is a simple version of a price index. A better measure would include information about the relative importance of each of the three goods in consumer’s budgets (you could then construct a weighted average as your price index, which is discussed in chapter 7).

2.     The unemployed are those who are not working for pay or profit but who have made specific efforts to find a job during the week of the employment survey. In simple terms, it is the excess of labor supplied over labor demanded in the market. The labor demand curve measures the quantity of labor (workers or hours) demanded by firms at each possible wage rate. Firms’ demand for labor is derived from the demand for products. Firms will hire workers as long as the product of their labor sells for a price high enough to produce a profit. Thus, the “productivity” of workers is critical. Labor supply reflects the choices made by households to work and how much to work. The alternative to working is leisure or “home production.” Home production can include child rearing, subsistence farming, or other unpaid work. The value of leisure and home production is the opportunity cost of working.

8.     Wars result in high levels of government spending, which helps to increase total spending in the economy.

9.     Wrong. Incomes have actually risen faster than prices, so that the purchasing power of the average citizen has increased. Prices may now be higher in dollar amounts, but compared to people’s earnings, some goods may in fact be cheaper than they were in the 1940s.

12.    The classical belief is that markets are resilient and that wages and prices are flexible. Thus the decline in the demand for auto workers should result in lower wages. This will cause some workers to cease looking for work and will serve as an incentive for firms to increase the number of workers demanded. What would otherwise be a surplus (unemployment) in the labor market results in the market clearing, or no additional unemployment. Keynes argued that wages may not adjust right away. Thus the decline in the demand for labor is not met by a commensurate drop in the wage rate. This means that there will be many more auto workers actively seeking employment but much fewer being hired in the market, so unemployment will increase.

13.    Prior to the Great Depression, economists applied microeconomic, or classical, models to economy-wide problems. Classical models could not explain the Great Depression. According to classical models, the economy is self-correcting and unemployment should not persist. During the Great Depression, very high levels of unemployment persisted for about 10 years. Because classical models could not explain the Great Depression, the approach to macroeconomics had to be rethought.

Courtesy of Case/Fair/Oster, 11th edition, 2014