1. In the Dornbusch-Fischer-Sparks textbook, the production function for the economy is given by Y = aN, where Y is output, N is employment and a is a constant:

(a) What happens to the marginal product of labour as employment increases?

(b) Describe the demand curve for labour if firms pay workers the value of their marginal product.

(c) Combining this demand curve with a "standard" labour-supply curve, indicate what happens to the real wage and employment, when there is an exogenous increase in a in the production function.

2. This question deals with reservation wages.

(a) If you have no income from nonwage sources, why would you choose to work no matter how low the wage rate is?

(b) If all persons in the economy experience the same lack of nonwage income, why is the labour-supply curve vertical?

3. Assume that the government passes legislation that forces everyone to retire at the age of 63 instead of 65 as was previously the case.

(a) How will this influence consumption expenditures, investment expenditures and total output in an IS-LM model (i.e., prices are constant)?

(b) How will this influence the supply of labour, equilibrium employment and the equilibrium real wage?

*(c) In a complete macromodel, what will be the effect on output, the inflation rate and the unemployment rate in the short run while nominal wage growth is fixed?

*(d) In the long run, what further adjustments will occur in the inflation rate and will the effect in (a) or (b) above dominate the determination of output?

4. If all workers who were paid every week are now paid once a year, it is unlikely that the demand for money would change very much. Why?

5. "Electronic banking, which substantially reduces the cost of moving from one asset to another, is just around the corner and we can expect a major, once-and-for-all increase in the velocity of money."

(a) Explain this statement in terms of optimal money holdings.

*(b) What is the long-run effect on output, inflation, and interest rates?

*(c) What happens to these variables if the increase in velocity is unexpected?

*(d) If there are any undesirable effects in (c), what can the central bank do to counter them?

6. How does a Christmas bonus affect consumption expenditures?

7. "Although it is well known that investment expenditures are negatively related to the interest rate, one should also realize that they are positively related to the wage rate." Explain this statement.

8. Why does an increase in the demand for currency on the part of the public affect the supply of money (i.e., currency plus demand desposits)?

9. During the Great Depression of the 1930's, consumption expenditures exceeded disposable personal income. Does that make the marginal propensity to consume negative? How would you explain such an outcome?

10. If banks double the cost of writing cheques, what happens to the supply of M1 (currency plus demand deposits), income and the interest rate?

11. Show in a diagram a person who has some nonwage income and is indifferent between working H hours and not working at all.

(a) Indicate the reservation wage.

(b) If the government now taxes a part of all income, show the new budget line and indicate whether the person is more likely to supply H hours of work now.

(c) Instead, show that this person will offer to work more hours if an overtime premium is paid (e.g. time-and-a-half for any hour above H).

12. The Canadian government has decided to spend $10 billion on retraining, moving subsidies, etc. to eliminate any immobility in the labour market so that firms will always be able to find the right worker for any vacancy that they have.

(a) Why is this type of expenditure different than the purchase of paper clips?

*(b) How will this affect prices, output, real wages and employment in the long run after nominal wages have had a chance to adjust?

*(c) Will the budget deficit increase by $10 billion?

13. "One explanation for the extraordinary increase in consumption expenditures in 1989 was that many workers received unexpected bonuses."

(a) Why is this not an acceptable "explanation?"

(b) Would an increase in the rate of time preference be a better explanation?

(c) If the rate of time preference must equal the interest rate, is it possible for both to be higher in a new equilibrium in an IS-LM framework?

14. "One explanation for the heavy investment expenditures in computers is their high rate of depreciation."

(a) Is this a reliable explanation?

(b) Would an increase in the wage rate be a better explanation?

(c) Would an increase in the wage rate make the IS curve steeper?

15. "One explanation for the lower demand for money is that banks have raised their cheque-writing charges."

(a) Why is this not a reliable explanation?

(b) Would a better explanation be that financial institutions in general have lowered their transfer charges between assets because of technical improvements?

(c) As a result of these technical improvements, what happens to income and the interest rate?

16. "One reason for the higher natural rate of unemployment in the 1970's compared to the 1950's and 1960's is the increase in unemployment insurance payments which raised the reservation wage of those who received these payments and made them less willing to work." Carefully analyze the conclusion reached in this statement.

17. If the empirical evidence suggests that current consumption falls as interest rates rise, what happens to the slope of the IS curve? Does an increase in the money supply cause output to rise more or less than if consumption were not responsive to the interest rate?

18. If individuals stopped optimizing their money balances because of the high cost of "shoe-leather," what happens to the income and interest elasticities of the demand for money? Does this mean that the central bank can no longer control interest rates and aggregate demand?

19. The inventory rule for optimal transactions balances indicates that the interest elasticity of the demand for money is - 0.5.

(a) Why would the actual elasticity be absolutely smaller?

(b) Why would the elasticity be absolutely smaller for M2 than for M1?

20. This question deals with two-period consumption decisions.

(a) Diagrammatically show how an increase in the current interest rate could cause you to save more in the current period.

(b) If this behaviour held for all persons, what happens to the slope of the IS curve compared to a Keynesian consumption function?

21. Assume that there are higher shoe-leather costs in the money market.