Answers to Review Questions

Macro Chapters 11a-12a

Extra Stuff . . Chapter 11a . . Chapter 12a

 Answers to questions as they were in July, 2006

Business-Cycle Theories


Exploring Business Cycles

1. The dating of recessions is not done by the U.S. government. Rather it is done by a private organization, the National Bureau of Economic Research. Visit them on the web at <> and find out when the last recession took place.

Internet exploration

2. Simple models with interesting adjustment patterns can be constructed using the idea of contingent behavior. For example, suppose that Peter will wear a tie only if Ed did the previous day, Ed will wear a tie only if Peter did the previous day, and Matt will wear a tie only if Peter did the previous day.

a) On Tuesday Peter is wearing a tie and Ed and Matthew are not. What will the adjustment path be?

This cycles forever. Next day Ed and Matt wear a tie, and Peter does not. Day after we are back to the initial situation. Etc.

b) On Tuesday Peter and Ed are wearing a tie and Matthew is not. What will the adjustment path be?

Everyone wears ties.

c) On Tuesday Matthew is wearing a tie and Ed and Peter are not. What will the adjustment path be?

No one wears a tie.

Feedback: A Little Quiz

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Exploring Cycle Financing

4. Chile had a tumultuous economic record during the 1970s and 1980s. It suffered a major inflation and two severe recessions. Column 1 in the table below shows the annual rate of change in money stock for the years 1970 through 1983. The table also shows rates of inflation and changes in manufacturing output. However, the three blocks showing inflation and changes in output, labeled A, B, and C, are not in the right order. What is the proper order for these blocks? (Hint: The correct order is the one that is most consistent with the predictions of inflation that the quantity theory gives.)

Not only has Chile had wide variations in monetary growth, but it has had equally drastic changes in other aspects of economic policy. In November of 1970 Salvador Allende won the presidency and began to transform Chile into a socialist society by nationalizing industries and by discouraging private business in a variety of ways. He was overthrown in a military coup in September of 1973. The ensuing military dictatorship cut government control of the economy, denationalizing some industries, and cutting regulation for others. One could expect that these large nonmonetary changes would be more important than the monetary changes. Given the data above, how much of the price changes seem to be explainable in terms only of changes in money? (Almost all, most, half, a bit, almost none?) How much of the changes in manufacturing output can be explained solely in terms of changes in money? Can more of the price movements or more of the output changes be explained in terms of money? (Comment: You might try graphing all three series together. A picture is worth a thousand words.)

Correct order is BCA. Inflation is largely determined by money, with a lag. The relationship between money and change in manufacturing is not as simple or strong.


Percentage Change in Money

Percentage Change in Prices
Percentage Change in Manufacturing




































Source: Computed from data in International Financial Statistics, various issues.

Exploring The Neutral Rate

5. Wicksell talked about the natural rate of interest. Today there is discussion about something called the neutral rate of interest. Search the internet for "neutral rate" or "neutral rate of interest." What is it and why is it considered important? Search the internet for both "neutral rate" and "natural rate of interest." Are they the same concept? If they are not, what is the difference?

Internet exploration You should find they are the same concept. The neutral rate is important because most central banks use interest rates as a policy target, and unless one knows what the neutral rate is, one cannot tell if monetary policy is easy or tight.


Extra Stuff . . Chapter 11a . . Chapter 12a


The Simple Multiplier Model--I

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2. Normally the marginal propensity to consume should be between zero and one.

a) How would people act if their mpc was greater than one? Do you know anyone who acts that way?

When they got more income, they would not only spend all the additional income they got, but a bit more. Credit cards let some people do this.

b) Suppose the marginal propensity to consume were negative. What would this mean in terms of people's behavior?

When people got more income, they would cut spending. That would be pretty strange.


The Simple Multiplier Model--Part II

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Exploring Activism

4. In the middle of the 14th century the Black Death first visited Europe, and in the following decades it made repeated visits. The plague destroyed about one third of the population, but did not destroy land, capital, housing, or money. What does the simple income-expenditure model predict would happen as a result of the plague to output and price level? (Hint: Use the Aggregate Demand and Supply graph.)

Since the simple model does not include price level, it says nothing about whether price level rose or fell. Everything in the simple model is a demand shock, so the reduction in income is due to the fact that people spend less--there are fewer people.

Resource Markets

Exploring Derived Demand

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(Why do college professors earn more now than in the past if they are not more productive? Two reasons. There is more demand for college education. And the opportunity cost of being a college teacher has risen because there are many opportunities for people with the talent to teach college.

Exploring Search

2. The theory of search applies not just to the labor market, but many other markets as well. Answer the following by identifying the costs and benefits of search.

a. Suppose you are moving to another city and must sell your house. Will you take the first offer you receive? How will you decide when to stop rejecting offers and accept one?
b. When you searched for a college, how many colleges did you investigate? Why did you not investigate one more?
c. When a person buys a new car, he generally visits several car dealers to compare prices and products. A person searching for a new toothbrush rarely visits more than one "toothbrush dealer." Why do people spend a lot of time searching for a new car but so little for a new toothbrush?
d. Suppose a person has had his car wrecked. Would you expect him to search more, less, or the same as a person who wants to buy a new car because his present car is getting old?
e. People search for marriage partners in the "marriage market." (Marriage is a contract.) Will people spend more time searching when divorce laws allow quick and easy divorces, or when no divorce is allowed?

Answers may vary a bit. The higher the price of the article, the greater the potential gain from search, so we expect more search when the price is higher or the variation in prices is greater. If a person needs an item immediately, they can not search and will generally pay more. If the costs of making a bad decision are high, people will search longer.

Exploring the Phillips Curve

3. When unemployment and inflation for the 1950s and 1960s were plotted together, they revealed the Phillips Curve. When the data for the 1970s and 1980s were added, the Phillips Curve disappeared. What does the data for the past 15 years show? Find out by plotting them. You can get data on rates of unemployment and inflation at <>. Another site with lots of data is <>

 Internet exploration. Answers will depend on when the data is collected.


Extra Stuff . .Chapter 11a . . Chapter 12a