QUIZ2Macro–Winter2002-BoothSchoolofBusiness.docVIP

QUIZ 2: Macro – Winter 2014 Name: __ANSWERS________ Section Registered: Friday a.m. Friday p.m. Saturday a.m. Quiz assumptions: These hold for BOTH questions 1 and 2. When answering these questions, you should compare the initial position of the economy to the new equilibrium in the economy (inclusive of both income and substitution effects). That means, we will assume the labor market will always clear. Additionally, unless I tell you otherwise, all other exogenous variables-- TFP, taxes, population, value of leisure, changes in wealth-- (and the capital stock) are held fixed. Question 1 (2 points each – 10 points total) For questions 1a – 1e, circle the answer that makes the question stem true. When answering the questions, you should only use the models developed in class (including assuming a Cobb-Douglas production function). For each question stem, there is only one true answer. a. A temporary increase in TFP (A) will: Unambiguously shift the labor supply curve to the right. Unambiguously shift the labor supply curve to the left. Unambiguously have no effect on the labor supply. The labor supply curve will shift to the right or the left depending on whether income effects are large or small compared to substitution effects. Start with the Cobb Douglas production function: Y = AK0.3N0.7. Taking the partial derivative with respect to N gives us: MPN = 0.7A(K/N)0.3. As A increases, MPN increases. Firm optimization results in MPN = W/P (this is our labor demand curve). From this identity, we can easily see that a temporary increase in A holding all else constant will shift the labor demand curve up (or to the right). Using our labor market analysis, the temporary increase in TFP will result in a temporary increase in W/P (when workers are more productive they are more valuable to the firm). Because this is a temporary wage increase, lifetime income will move but only by a small amount. As I said in the Supplem