Macroeconomics, 8e (Abel/Bernanke/Croushore)
Chapter 10 Classical Business Cycle Analysis
10.1 Business Cycles in the Classical Model
1) The theory that real shocks to the economy are the primary cause of business cycles is
A) monetarism.
B) Keynesian theory.
C) real business cycle theory.
D) Hamiltonian theory.
2) Which of the following is not a primary cause of business cycle fluctuations, according to real
business cycle theory?
A) A change in the production function
B) A change in the size of the labor force
C) A change in the money supply
D) A change in the real quantity of government purchases
3) The distinction between real and nominal shocks is that
A) real shocks directly affect only the IS curve, but not the FE line or LM curve.
B) real shocks directly affect only the FE line, but not the LM curve.
C) real shocks directly affect only the IS curve or the FE line, but not the LM curve.
D) real shocks have a large direct effect on the IS curve and the FE line, but only a small direct
effect on the LM curve.
4) Real business cycle theorists think that most business cycle fluctuations are caused by shocks
to
A) the production function.
B) the size of the labor force.
C) the real quantity of government purchases.
D) the spending and saving decisions of consumers.
5) According to real business cycle theory, which of the following events is least likely to cause
a recession?
A) A decline in the money supply
B) A decline in the capital stock
C) A decline in productivity
D) A decline in labor supply
6) Which of the following is an example of a productivity shock?
A) The introduction of new management techniques
B) A change in taxes on corporate profits
C) A change in the level of government transfer programs
D) An increase in the money supply
7) Which of the following would not be an example of a productivity shock?
A) The introduction of new management techniques
B) A change in government regulations affecting production
C) A change in the level of government transfer programs
D) A spell of unusually good or unusually bad weather
8) A temporary adverse productivity shock would
A) shift the labor supply curve upward.
B) decrease the level of employment.
C) decrease future income.
D) decrease the expected future marginal product of capital.
9) A temporary beneficial productivity shock would
A) shift the labor supply curve down and to the right.
B) increase the level of employment.
C) increase future income.
D) increase the expected future marginal product of capital.
10) In the classical IS-LM/AD-AS model, a beneficial productivity shock would ________
output, ________ the real interest rate, and ________ the price level.
A) increase; decrease; increase
B) increase; decrease; decrease
C) increase; increase; decrease
D) decrease; decrease; increase
11) An adverse supply shock would directly ________ labor productivity by changing the
amount of output that can be produced with any given amount of capital and labor. It would also
indirectly ________ average labor productivity through changes in the level of employment.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
12) How do RBC economists face the business cycle fact that inflation is procyclical?
A) They argue that even though inflation doesn’t fit their theory, everything else does, and
inflation is not important.
B) They note that inflation would not be procyclical if monetary policy were conducted properly.
C) They argue that inflation is procyclical only because monetary policy shocks are the main
cause of business cycles.
D) They use alternative statistical methods that suggest that inflation is countercyclical.
13) When RBC economists work out a detailed numerical example of a more general theory, they
are performing
A) econometrics.
B) number theory.
C) calibration.
D) topology.
14) What do RBC economists mean by the term calibration?
A) Modifying the structure of an economic theory to strengthen its logic
B) Changing a theory as the economy changes
C) Working out a detailed numerical example of a more general theory
D) Writing out the implications of a theory for all the main economic variables
15) When RBC economists compare the volatility in their models to the data, what are they
looking at?
A) The degree to which variables lead output over the business cycle
B) The strength of procyclicality of different variables
C) The amount of random variation in economic variables
D) The degree to which different economic variables move together
16) When RBC economists compare the correlations in their models to the data, what are they
looking at?
A) The degree to which variables lead output over the business cycle
B) The strength of procyclicality of different variables
C) The amount of random variation in economic variables
D) The degree to which different economic variables move together
17) Prescott’s calibrated RBC model showed that the actual and simulated ________ of five key
macroeconomic variables were very close.
A) magnitudes
B) slopes
C) volatilities
D) betas
18) Prescott’s calibrated RBC model was able to match the data in terms of the ________
between many key macroeconomic variables and GNP; that is, in terms of how closely they
moved with GNP over the business cycle.
A) correlation
B) interdependence
C) gamma coefficient
D) sigma ratio
19) Research on productivity shocks has shown that
A) productivity shocks have only nominal effects.
B) there have been no identifiable productivity shocks in the U.S. economy since World War II.
C) small productivity shocks can explain large business cycle fluctuations.
D) large productivity shocks produce only small deviations in aggregate output.
20) The most common measure of productivity shocks is known as
A) the Solow residual.
B) the Lucas supply curve.
C) the Prescott productivity parameter.
D) the Kydland factor.
21) The most common measure of productivity shocks used by real business cycle theorists is
A) the Solow residual.
B) average labor productivity.
C) the change in the capital stock.
D) unit labor costs.
22) The Solow residual is
A) the waste from the production process.
B) the most common measure of productivity shocks.
C) a measure of the efficiency of the production process.
D) a measure of the proportion of involuntarily unemployed workers.
23) Given data on capital (K), labor (N), and output (Y), and estimates of capital’s share of output
(a), the Solow residual is measured as
A) Y KaN1-a
B) (Y Ka) / N1-a
C) Y / (KaN1-a)
D) 1/(Y KaN1-a)
24) The formula Y / (KaN1-a) provides a calculation of
A) x-efficiency.
B) dynamic efficiency.
C) economywide monopoly power.
D) the Solow residual.
25) Measures of the Solow residual show it to be
A) strongly procyclical.
B) mildly procyclical.
C) mildly countercyclical.
D) strongly countercyclical.
26) One important reason why the Solow residual may be strongly procyclical even if the actual
technology used in production doesn’t change is that
A) employment is procyclical.
B) resource utilization is procyclical.
C) demand shocks are the dominant force determining the business cycle.
D) the coefficients (a and 1 – a) on capital and labor in the production function are procyclical.
27) If the utilization rates of capital and labor are procyclical, then
A) output will rise in recessions and decline in expansions.
B) measured productivity will be constant.
C) the Solow residual will be procyclical.
D) prices will be countercyclical.
28) If the utilization rates of capital (uK) and labor (uN) are procyclical, then the Solow residual,
as conventionally measured, is
A) Y [(uK K)a (uN N)1-a]
B) Y / [(uK K)a (uN N)1-a]
C) A
D) 1/{Y [(uK K)a (uN N)1-a]}
29) Labor hoarding occurs when
A) firms keep good workers so other firms can’t hire them.
B) the unemployment rate exceeds the natural rate of unemployment.
C) involuntary unemployment exceeds voluntary unemployment.
D) because of hiring and firing costs, firms retain workers in a recession that they would
otherwise lay off.
30) When, because of hiring and firing costs, firms retain workers in a recession that they would
otherwise lay off, there is said to be
A) labor hoarding.
B) a decline in capacity utilization.
C) voluntary unemployment.
D) involuntary unemployment.
31) Braun and Evans found that
A) the measured Solow residual varied sharply over the seasons.
B) electricity use by producers rises sharply in economic upturns.
C) professional forecasters have rational expectations of inflation.
D) shocks to fiscal policy are the main source of business cycle fluctuations.
32) Critics of the RBC approach argue that it’s hard to find productivity shocks large enough to
cause business cycles. What is the RBC counterargument to this criticism?
A) Business cycles are always and everywhere a monetary phenomenon.
B) Wars and military buildups could be considered productivity shocks.
C) Business cycles could be caused by the accumulation of small productivity shocks.
D) Business cycles are often caused by unobservable productivity shocks, which aren’t apparent
at the time they occur.
33) Models that are similar to RBC models but allow for shocks other than productivity shocks
are known as
A) DSGE models.
B) Keynesian models.
C) Solow models.
D) Friedman models.
34) DSGE models are
A) similar to RBC models but allow for shocks other than productivity shocks.
B) similar to RBC models, but government spending shocks play a major role.
C) similar to Keynesian models except in the long run.
D) similar to Keynesian models except in the short run.
35) Classical economists who allow for shocks other than productivity shocks to affect the
economy use ________ models rather than RBC models.
A) Keynesian
B) monetarist
C) nonlinear
D) DSGE
36) According to the real business cycle theory, what is the principal cause of business cycle
fluctuations?
37) Define real shocks, define nominal shocks, and give an example of each.
38) How do RBC theorists answer the objection that there have been few examples of large and
easily measurable real shocks to the U.S. economy in recent decades?
39) Use the classical (RBC) IS-LM–FE model to show the effects on the economy of a temporary
beneficial supply shock-for example, a decrease in the price of oil. You should show the impact
on the real wage, employment, output, the real interest rate, consumption, investment, and the
price level.
40) Use the classical (RBC) IS-LM–FE model to show the effects on the economy of a temporary
adverse supply shock-for example, an increase in the price of oil. You should show the impact on
the real wage, employment, output, the real interest rate, consumption, investment, and the price
level.
41) Describe, in general terms, how an economist calibrates a macroeconomic model. What
statistics can be usefully examined to see how well the model corresponds to the data?
42) How is the Solow residual measured? What problems arise in its measurement when
resource utilization varies over the business cycle? What implications do these measurement
issues have for evidence supporting the RBC model?
10.2 Fiscal Policy Shocks in the Classical Model
1) A temporary increase in government purchases in the classical model would
A) shift the production function to the right.
B) shift the marginal product of labor curve to the left.
C) shift the labor demand curve to the right.
D) shift the labor supply curve to the right.
2) In the classical model, a temporary increase in government purchases causes
A) a decrease in output and the real interest rate.
B) a decrease in output and an increase in the real interest rate.
C) an increase in output and a decrease in the real interest rate.
D) an increase in output and the real interest rate.
3) A temporary decrease in government purchases in the classical model would
A) shift the production function to the left.
B) shift the marginal product of labor curve to the right.
C) shift the labor demand curve to the left.
D) shift the labor supply curve to the left.
4) In the classical model, a temporary decrease in government spending would cause a decrease
in
A) output, the real interest rate, real wages, and the price level.
B) employment, the real interest rate, real wages, and the price level.
C) output, employment, the real interest rate, and the price level.
D) output, employment, real wages, and the price level.
5) Classical economists would cite all of the following as reasons why the government cannot
smooth out the business cycle EXCEPT that
A) only productivity shocks can cause real fluctuations in the business cycle.
B) the government has imperfect knowledge of the economy.
C) political constraints on policy actions prevent the government from carrying out effective
policies.
D) time lags between the onset of a recession and the implementation of effective
countermeasures make anti-recessionary macroeconomic policies impractical.
6) According to classical economists, the government should increase government purchases
when
A) the benefits of the spending exceed the costs.
B) the economy is in a recession.
C) the economy is likely to go into a recession in the next six months to a year.
D) inflation is lower than its targeted level.
7) Classical economists think that the government ________ use fiscal policy to dampen the
business cycle because prices and wages adjust ________.
A) should not; rapidly
B) should not; slowly
C) should; slowly
D) should; rapidly
8) During a recession, would classical economists propose that changes in government spending
or taxes be used to improve economic conditions? Briefly explain.
9) Suppose the economy’s production function is Y = A(300N – N2). The marginal product of
labor is MPN = A(300 – 2N). Suppose that A = 10. The supply of labor is NS = 0.05w + 0.005G.
(a) If G is 26,000, what are the real wage, employment, and output?
(b) If G rises to 26,400, what are the real wage, employment, and output?
(c) If G falls to 25,600, what are the real wage, employment, and output?
(d) In cases (b) and (c), what is the government purchases multiplier; that is, what is the change
in output divided by the change in government purchases?
10) Use the classical IS–LM model to show the effects of a temporary decrease in government
purchases on the equilibrium levels of output, the real interest rate, employment, the real wage,
and the price level.
10.3 Unemployment in the Classical Model
1) According to classical economists, the increase in unemployment in recessions is caused by
A) slack aggregate demand.
B) the failure of wages to adjust to restore equilibrium in the labor market.
C) the power of labor unions, which prevent firms from cutting wages.
D) a mismatch of workers and jobs.
2) According to classical economists, unemployment rises in recessions due to an increase in
________ unemployment, not ________ unemployment.
A) cyclical; frictional and structural
B) frictional and cyclical; structural
C) structural; frictional and cyclical
D) frictional and structural; cyclical