Chapter 3 Mishkin (3)

Macreconomics: Policy and Practice (Mishkin) Chapter 3 Aggregate Production and Productivity 3.1 Determinants of Aggregate Production 1) Which of the following constitutes an input to the Cobb-Douglas production function? A) capital B) labor C) total factor productivity D) all of the above E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production 2) To analyze aggregate productivity, economists typically assume ________. A) that the hours each person works varies with the wage rate B) that all of the capital and labor in the economy are fully utilized C) that output can increase only if inputs have become more productive D) all of the above E) none of the above Answer: B Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 3) The output an economy can produce with one unit of capital and one unit of labor is ________. A) indicated by the A variable in the Cobb-Douglas production function B) commonly referred to as labor productivity C) a variable that depends on how many units of capital and labor are available D) all of the above E) none of the above Answer: A Topic: 3.1 Determinants of Aggregate Production 4) What does the Cobb-Douglas production function assume about the input shares in the economy? A) the capital share is larger than the labor share of income B) both the capital and labor shares of income grow over time C) both the capital and labor shares of income remain relatively constant over time D) the capital share of income is equal to the labor share of income E) none of the above Answer: C Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking

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5) What does the Cobb-Douglas production function assume about the input shares in the economy? A) the capital share is smaller than the labor share of income B) both the capital and labor shares of income are positive C) both the capital and labor shares of income remain relatively constant over time D) all of the above E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 6) Which of the following is true about labor productivity? A) it is the amount of total factor productivity (TFP) per unit of labor B) it is more difficult to measure than TFP C) it is a more general and better measure of productivity than TFP D) all of the above E) none of the above Answer: E Topic: 3.1 Determinants of Aggregate Production 7) Which of the following is true about labor productivity? A) it is the amount of output produced per unit of labor B) it is easier to measure than total factor productivity (TFP) C) it is more commonly mentioned in the media than total factor productivity (TFP) D) all of the above E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production 8) Which of the following is true about total factor productivity (TFP)? A) it tells us how productive capital and labor are B) it is a more general and better measure of productivity than labor productivity C) it is not directly measurable D) all of the above E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills

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9) Which of the following is true about total factor productivity (TFP)? A) it can be measured just like capital and labor B) it cannot be directly measured so it has to be calculated from given values of capital, labor and output C) while it cannot be measured directly, it has an exponent of 0.3 in the Cobb-Douglas production function D) while it cannot be measured directly, it has an exponent of 0.7 in the Cobb-Douglas production function E) none of the above Answer: B Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 10) Suppose than an economy has output Y = AK0.3L0.7, that Y equals $12 trillion, capital K is $27 trillion, and labor L is 64 million workers. Given this information, what is the closest approximation of total factor productivity A? A) less than 0.01 B) around 0.25 C) roughly 0.33 D) close to 0.4 E) exactly 144 Answer: B Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 11) Suppose than an economy has output Y = AK0.3L0.7, that Y equals $19 trillion, capital K is $27 trillion, and labor L is 125 million workers. Given this information, what is the closest approximation of total factor productivity A? A) less than 0.01 B) around 0.25 C) roughly 0.33 D) close to 0.4 E) exactly 144 Answer: B Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills

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12) Suppose than an economy has output Y = AK0.3L0.7, that Y equals $42 trillion, capital K is $64 trillion, and labor L is 125 million workers. Given this information, what is the closest approximation of total factor productivity A? A) less than 0.01 B) around 0.25 C) roughly 0.33 D) close to 0.4 E) exactly 144 Answer: D Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 13) Given the production function Y = AK0.3L0.7, if an economy's capital per worker k is $27 thousand, and its total factor productivity A is 0.5, then output per worker is (approximately) ________. A) $13,500 B) $40,500 C) $3,000 D) $5,000 E) $1,500 Answer: E Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 14) Which of the following is true about per capita income? A) it is an approximate measure of how rich or poor a country is B) it is the same as income per worker only if everyone in the economy is assumed to work C) it is the product of TFP and capital per worker only if everyone in the economy is assumed to work D) all of the above E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 15) From the Cobb-Douglas production function we learn that there are two sources that help explain cross-country differences in per capita income:________ and ________. A) capital; labor productivity B) labor share of income; TFP C) TFP; capital per person D) labor per person; capital E) none of the above Answer: C Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills

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16) If country X has a higher capital per person than country Y, then ________. A) country X is richer than country Y B) the only way for country X to be richer than country Y is if X is just as productive (has the same TFP) as Y C) the only way for country Y to be richer than country X is if Y is more productive (has a higher TFP) than X D) the only way for country X to be richer than country Y is if X is less productive (has a lower TFP) than Y E) none of the above Answer: C Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 17) The main cause of low per capita income is ________. A) a low level of capital B) a small workforce C) low productivity of capital and labor D) slow growth of capital and labor shares of income E) none of the above Answer: C Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 18) What do you think would be the Cobb-Douglas single best prescription for poor countries to catch up with the rich? A) to increase their stock of capital B) to increase their labor force C) to find more efficient ways to allocate and use capital and labor D) to ask help of the rich countries E) none of the above Answer: C Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 19) Capital per person k is higher in Japan than in the United States. As a result ________. A) per capita income is higher in Japan B) total factor productivity is higher in Japan C) the marginal product of capital is higher in Japan D) all of the above E) none of the above Answer: E Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills

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20) A ten percent increase in total factor productivity A will increase ________. A) the marginal product of capital (MPK) by ten percent B) the marginal product of labor (MPL) by ten percent C) output by ten percent D) all of the above E) none of the above Answer: C Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 21) Constant returns to scale (CRS) implies that ________. A) increasing all the factor inputs by the same percentage lead to the same percentage increase in output B) increasing all the factor inputs by the same percentage lead to a higher percentage increase in output C) increasing all the factor inputs by the same percentage lead to a lower percentage increase in output D) increasing all the factor inputs by the same percentage leaves output unchanged E) none of the above Answer: A Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 22) Constant returns to scale (CRS) implies that when the firm ________. A) doubles all inputs, output more than doubles B) doubles all inputs, output doubles C) doubles all inputs, output increases by less than 100 percent D) doubles all inputs, output remains constant E) none of the above Answer: B Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 23) Using the Cobb-Douglas production function, while holding other inputs constant, if the amount of a specific factor is increasing ________. A) the increased amount of output from an extra unit of input declines B) the increased amount of output from an extra unit of input increases C) that factor's share of output is declining D) that factor's share of output is increasing E) none of the above Answer: A Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills

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24) Diminishing marginal product means that ________. A) when adding extra units of a single input, output increases become smaller B) when adding extra units of a single input, output increases become larger C) when adding extra units of a single input, output declines D) the amount of output increases when we add more inputs E) none of the above Answer: A Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 25) The marginal product of capital (MPK) measures ________. A) by how much output increases for each additional unit of capital B) by how much capital increases for each additional unit of output C) by how much capital increases for each additional unit of labor D) by how much total factor productivity increases for each additional unit of capital E) none of the above Answer: A Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 26) Which of the following will cause an increase in the marginal product of capital (MPK)? A) a decrease in the quantity of labor in use B) an increase in labor productivity C) a decrease in the quantity of capital in use D) all of the above E) none of the above Answer: C Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 27) As the capital stock increases,________. This means that the marginal product of capital (MPK)________. A) the slope of the production function falls; declines B) the slope of the production function increases; goes up C) the slope of the production function falls; goes up D) the slope of the production function increases; declines E) none of the above Answer: A Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills

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28) The marginal product of capital (MPK) is given by the ________. A) capital share of income + average output per unit of capital B) capital share of income - average output per unit of capital C) capital share of income ÷ average output per unit of capital D) capital share of income × average output per unit of capital E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 29) The marginal product of capital (MPK) can be calculated from the following ________. A) the capital share of income and the average output per unit of capital B) the capital share of income and average capital per worker C) output and capital D) the capital share of income and output E) none of the above Answer: A Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 30) What do we learn from the shape of the Cobb-Douglas production function? A) its slope falls as capital gets added B) the marginal product of capital declines as the capital stock increases C) there are diminishing returns to capital D) all of the above E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 31) The marginal product of labor (MPL) measures ________. A) by how much labor increases for each additional unit of output B) by how much labor increases for each additional unit of capital C) by how much total factor productivity increases for each additional unit of labor D) by how much labor increases for each additional unit of productivity E) by how much output increases for each additional unit of labor Answer: E Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills

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32) As the amount of labor input increases ________. This means that the marginal product of labor (MPL)________. A) the slope of the production function increases; goes up B) the slope of the production function falls; declines C) the slope of the production function falls; goes up D) the slope of the production function increases; declines E) none of the above Answer: B Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 33) What do we learn from the shape of the Cobb-Douglas production function? A) its slope remains constant as labor input increases B) the marginal product of labor declines as the labor input falls C) there are diminishing returns to labor D) all of the above E) none of the above Answer: C Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 34) The marginal product of labor (MPL) is given by the ________. A) labor share of income + average output per unit of labor B) labor share of income - average output per unit of labor C) labor share of income ÷ average output per unit of labor D) labor share of income × average output per unit of labor E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 35) The marginal product of labor (MPL) can be calculated from the following ________. A) the labor share of income and the average output per unit of labor B) the labor share of income and average labor per worker C) output and labor D) the labor share of income and output E) none of the above Answer: A Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills

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36) Constant returns to scale (CRS) implies ________. A) constant returns to labor B) constant returns to capital C) increasing marginal products D) variable total factor productivity E) diminishing marginal products Answer: E Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 37) An example of a supply shock could be ________. A) a technological innovation B) a natural disaster C) an oil price increase D) all of the above E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 38) A technology shock could have a different impact than a natural catastrophe because ________. A) the former would likely lower TFP and the latter raise labor productivity B) the former would likely lower output and the latter raise production C) the former would likely raise output and the latter would raise TFP D) the former would likely lower labor productivity and the latter would lower TFP E) the former would likely raise TFP and the latter would curtail production Answer: E Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 39) Since the 1980s, China's output per person has increased tremendously. Which of these possible contributors to economic growth in China is a good example of a positive supply shock? A) high levels of saving and investment B) declining rate of population growth C) rising consumption of energy D) all of the above E) none of the above Answer: E Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking

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40) Which of the following is an example of an adverse supply shock? A) OPEC cuts oil production B) a large oil spill in the Gulf of Mexico C) a devastating hurricane off the Louisiana coast D) all of the above E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 41) Suppose that labor productivity in one economy is higher than it is in some other economy. Does that mean that the first economy is using its productive resources better than the second economy? Explain. Answer: Higher labor productivity does not necessarily mean better use of resources. The economy may have more capital per worker, but the productivity of capital may be higher in the second economy. To compare use of resources across economies or over time, the correct measure is total factor productivity. Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 42) Use the Cobb-Douglas production function to explain why even massive movements of labor and capital across national borders may have little impact on differences in per capita income. Answer: Relatively low per capita income may be due to low total factor productivity or to low capital per worker. In the latter case, migration of capital or of labor could reduce inequality. In the former case, however, rising levels of capital in a low-income economy will do little to raise output per person. Declines in the labor input due to out-migration from a low-income economy might mean more capital for each of the remaining workers but, again, the increase in output per worker will be small if total factor productivity is low. Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 43) Capital per person in India is about five percent and per capita income is about nine percent of the U.S. level. Given that per capita income y = Ak0.3, calculate the level of total factor productivity (A) , relative to the U.S. level, that would be needed for India to match the U.S. level of per capita income. (0.050.3 = 0.4) Answer: 1 = A × 0.4 implies A = 2.5 Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills

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44) Use the Cobb-Douglas production function to show that a one-unit increase in the labor input will reduce the marginal product of labor and increase the marginal product of capital. Explain each of these results. Answer: MPL = MPK =

0.3 0.7 0.7 Y 0.7AK 0.3 = 0.7 AK L = . This ratio will decline when L rises. L L L0.3

0.3 0.7 0.3 Y 0.3 AL0.7 = 0.3 AK L = . This ratio increases with L. Adding more K K K 0.7

labor input causes the capital input to be spread more thinly (each unit of labor has less capital to work with), so output increases at a diminishing rate. More labor input means, also, that the available capital is being used more intensively (each unit of capital has more labor to work it), so the change in output that would result from a change in the quantity of capital is becoming larger. Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 45) Suppose an economy has an increase in labor input of 60 percent, while output has increased by 100 percent. Assuming no change in total factor productivity, calculate the percentage increase in the capital input. (Use the Cobb-Douglas production function Y = AK0.3L0.7.) Answer: 2Y = A(xK)0.3(1.6L)0.7. Dividing this by the original production function yields 2 = x 0.31.60.7. Solve for x = 3.37. The capital input has increased by 237 percent. Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Skills 3.2 Determination of Factor Prices 1) The classical framework is based on what assumption(s):________. A) many firms in the economy B) no single firm can control prices C) in the long-run the quantity of factors supplied must be equal to the quantity of factors demanded D) all of the above E) none of the above Answer: D Topic: 3.2 Determination of Factor Prices 2) In an environment characterized by perfect competition we expect that ________. A) there are very few firms in the economy B) there are many firms in the economy but a very few have the lion's share of the industry C) the are many small firms in the economy and every single firm is a price taker. D) the government sets prices for all firms E) none of the above Answer: C Topic: 3.2 Determination of Factor Prices

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3) Key determinants of economic profit include ________. A) the revenue from selling goods and services B) the cost incurred in buying capital C) the cost of hiring labor D) all of the above E) none of the above Answer: D Topic: 3.2 Determination of Factor Prices 4) Key influences on the valuation of economic profits include ________. A) the average level of the prices of goods and services sold B) the rental price of capital C) the wage rate D) all of the above E) none of the above Answer: D Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 5) Economic profits differ from accounting profits because ________. A) the former is calculated by economists and the latter by accountants B) many firms own their own capital so accounting profits do not factor this cost C) most firms report economic profits once a year and accounting profits every pay period D) all of the above E) none of the above Answer: B Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 6) Profit maximization implies that firms will want to ________. A) accumulate capital while the MPK is greater than the real wage B) accumulate capital while the MPK is greater than the rental price of capital C) accumulate labor while the MPK is greater than the rental price of capital D) accumulate labor while the MPK is greater than the real wage E) none of the above Answer: B Topic: 3.2 Determination of Factor Prices 7) Profit maximization implies that firms will want to ________. A) accumulate labor while the MPL is greater than the real wage B) accumulate capital while the MPK is lower than the rental price of capital C) accumulate labor while the MPK is greater than the rental price of capital D) accumulate capital while the MPL is greater than the real wage E) none of the above Answer: A Topic: 3.2 Determination of Factor Prices 13 Copyright © 2012 Pearson Education, Inc.

8) Profit maximization implies that firms will want to ________. A) accumulate labor while the MPL is greater than the real wage B) accumulate capital while the MPK is greater than the rental price of capital C) not accumulate either input without limit, because of diminishing returns to each factor D) all of the above E) none of the above Answer: D Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 9) Firms will continue to increase their purchase of factor inputs as long as ________. A) the marginal product of a given factor is greater than its real factor price B) the marginal cost of a given factor is lower than its marginal product C) their total revenues are greater than their total costs D) all of the above E) none of the above Answer: D Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 10) As firms use more and more of an input, ________. A) the marginal product of other inputs tends to increase B) the marginal product of the input declines C) the price of the input may increase D) all of the above E) none of the above Answer: D Topic: 3.2 Determination of Factor Prices 11) Which of the following is (are) likely to cause the marginal product of an input to decrease? A) an increase in the real price of the input B) a decrease in the quantity of the input used in production C) technological advances D) all of the above E) none of the above Answer: E Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking

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12) Which of the following is (are) likely to cause the marginal product of an input to decrease? A) an increase in the real price of the input B) a decrease in the quantity of other inputs used in production C) technological advances D) all of the above E) none of the above Answer: B Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 13) When a particular firm is fully utilizing its capital, its output is given by Y = 10 × L0.5. The cost of labor is $1 per unit. To maximize profit, how many units of labor should this firm use? A) 25 B) 5 C) 3.16 D) 100 E) 50 Answer: A Topic: 3.2 Determination of Factor Prices AACSB: Analytical Skills 14) In an economy with production function Y = 1.5 × K0.3L0.7, K = 343, and L = 512. If factor markets are in equilibrium, then the rental price of capital is (approximately) ________, and the real wage is (approximately) ________. A) 0.5; 0.8 B) 7; 8 C) 0.9; 1.35 D) 1.4; 0.4 E) 0.6; 0.9 Answer: E Topic: 3.2 Determination of Factor Prices AACSB: Analytical Skills 15) If the quantities of labor and capital in an economy each increase by the same x percent, which of the following will increase by x percent? A) marginal product of capital B) economic profits C) share of capital income in national income D) rental price of capital E) none of the above Answer: E Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking

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16) Assume that an economy is in equilibrium when the arrival of immigrants causes an increase in the supply of labor. Once the economy has adjusted to its new equilibrium, and assuming that the supply of capital remains unchanged, which of the following has decreased? A) the share of capital income in national income B) the share of labor income in national income C) national income D) the rental price of capital E) none of the above Answer: E Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 17) Assume that an economy is in equilibrium when technological progress causes an increase in total factor productivity. Once the economy has adjusted to its new equilibrium, and assuming that the supplies of capital and labor remain unchanged, which of the following has increased? A) the real wage B) the share of capital income in national income C) the share of labor income in national income D) all of the above E) none of the above Answer: A Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 18) Assume that an economy is in equilibrium when there occurs an increase in the supply of capital. The available quantity of labor remains fixed. Once the economy has adjusted to its new equilibrium, which of the following has increased? A) the real wage B) the rental price of capital C) the share of capital income in national income D) all of the above E) none of the above Answer: A Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 19) To get the first order conditions in a profit maximization problem, we must ________. A) set the profit function equal to zero and solve for the production function B) set the partial derivatives of the production function equal to zero and solve for the price C) set the partial derivative of the profit function equal to zero and solve for the marginal products D) set the production function equal to zero and solve for the marginal products E) none of the above Answer: C Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 16 Copyright © 2012 Pearson Education, Inc.

20) The marginal product of capital indicates ________. Therefore the MPK curve is also ________. A) the quantity of capital supplied for a given rental price; the equilibrium price of capital B) the quantity of capital demanded for a given rental price; the demand curve of capital C) the quantity of capital demanded for a given rental price; the equilibrium price of capital D) the quantity of capital supplied for a given rental price; the supply curve of capital E) none of the above Answer: B Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 21) The marginal product of labor indicates ________. Therefore the MPL curve is also ________. A) the quantity of labor supplied for a given wage; the equilibrium price of labor B) the quantity of labor demanded for a given wage; the equilibrium price of labor C) the quantity of labor demanded for a given wage; the demand curve of labor D) the quantity of labor supplied for a given wage; the supply curve of labor E) none of the above Answer: C Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 22) When the rental price of capital is above the equilibrium price ________. A) we have an excess supply of capital and the rental price should fall B) we have an excess demand of capital and the rental price should fall C) we have an excess supply of capital and the rental price should increase D) we have an excess demand of capital and the rental price should increase E) none of the above Answer: A Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 23) When the real wage is below the equilibrium price in the labor market ________. A) we have an excess supply of labor and the real wage should fall B) we have an excess demand of labor and the real wage should fall C) we have an excess demand of labor and the real wage should increase D) we have an excess supply of labor and the real wage should increase E) none of the above Answer: C Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking

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24) Real capital income is given by ________. A) MPK × K B) capital share of income × output per unit of capital × capital C) capital share of income × output D) all of the above E) none of the above Answer: D Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 25) Real labor income is given by ________. A) MPL × L B) labor share of income × labor productivity × labor C) labor share of income × output D) all of the above E) none of the above Answer: D Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 26) A decrease in the growth rate of labor productivity is likely to cause a decrease in ________. A) the growth rate of the real wage B) the growth rate of the marginal product of capital C) the growth rate of the labor supply D) the share of labor income in national income E) none of the above Answer: A Topic: 3.2 Determination of Factor Prices 27) An economy's total labor income is $2 trillion, and total capital income is $1 trillion. In the Cobb-Douglas production function, the exponent on capital is ________. A) two thirds B) one half C) one third D) 0.3 E) none of the above Answer: C Topic: 3.2 Determination of Factor Prices AACSB: Analytical Skills

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28) The three oil shocks the U.S. experienced in 1973-1974, 1979-1980 and 2007-2008 had a consistent result ________. A) a decline in real wages due to an upward shift of the production function B) an increase in the rental price of capital along with a healthy stock market response C) a decline in real wages due to a downward shift of the MPL curve D) an increase in the rental price of capital due to an upward shift of the production function E) none of the above Answer: C Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 29) An economy's production function is Y = AK0.3L0.7, and the economy's total output in equilibrium is $90 billion. Total capital income in this economy is ________. A) $27 billion B) $30 billion C) $21 billion D) $70 billion E) none of the above Answer: A Topic: 3.2 Determination of Factor Prices AACSB: Analytical Skills 30) An economy's production function is Y = AK0.3L0.7, and the economy's total output in equilibrium is $700 billion. Total labor income in this economy is ________. A) $300 billion B) $233.3 billion C) $210 billion D) $400 billion E) none of the above Answer: E Topic: 3.2 Determination of Factor Prices AACSB: Analytical Skills 31) An economy's production function is Y = AK0.25L0.75, and the economy's total output in equilibrium is $800 billion. Total capital income in this economy is ________. A) $200 billion B) $25 billion C) $750 billion D) $267 billion E) none of the above Answer: A Topic: 3.2 Determination of Factor Prices AACSB: Analytical Skills

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32) Equilibrium market prices for capital and labor are $10 and $8, respectively. Then, the economy experiences one or more supply shocks, so that the marginal product of capital is $12, and the marginal product of labor is $9. Assuming that the available quantities of capital and labor are fixed, which of the following is (are) likely to decrease as the economy approaches its new equilibrium? A) real rental price of capital B) total output C) economic profits D) the quantity of capital in use E) none of the above Answer: C Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 33) Equilibrium market prices for capital and labor are $10 and $8, respectively. Then, the economy experiences one or more supply shocks, so that the marginal product of capital is $9, and the marginal product of labor is $6. Assuming that the available quantities of capital and labor are fixed, which of the following is (are) likely to decrease as the economy approaches its new equilibrium? A) economic profits B) real rental price of capital C) total output D) the quantity of capital in use E) none of the above Answer: B Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 34) The three oil shocks the U.S. experienced in 1973-1974, 1979-1980 and 2007-2008 had a consistent result ________. A) a decline in the MPK B) a decline in the real rental price of capital C) a decline in stock prices D) all of the above E) none of the above Answer: D Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking

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35) As an investor, negative supply shocks are not attractive because ________. A) they tend to lead to lower productivity B) the real rental price of capital tends to decline driving rental incomes down C) with decreases in expected income, claims on those incomes also tend to fall leading to stock market downturns D) all of the above E) none of the above Answer: D Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 36) Suppose a government tried to mandate a real wage above the equilibrium real wage. Assuming that factor markets are otherwise free and competitive, explain why the higher real wage would fail to increase the share of labor income in national income. Answer: Given the Cobb-Douglas production function, the marginal product of labor is and the marginal product of capital is

0.7 Y , L

0.3Y . If each factor's price is equal to its marginal K

product, then its share of total income equals its exponent in the production function; 0.7 for labor, and 0.3 for capital. Firms will respond to the mandated higher real wage by reducing the quantity of labor demanded until the marginal product of labor is equal to the real wage. Workers who still have a job will have higher income, but many workers now have no job and no income. The reduced labor input lowers the marginal product of capital. Since the rental price of capital is unregulated, it will fall, so that no capital becomes idle. Since the prices of both labor and capital are equal to their respective marginal products, their shares of the reduced total output are unchanged. Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 37) Given the production function Y = AKαL1-α, if the rental price of capital is 0.133, Y = 690, and K = 1,728, what is the value of the exponent α? If A = 1, and the real wage is 1.15, is this economy in a long-run equilibrium? Answer: Since the rental price of capital equals the marginal product of capital, we have 0.133 = α690 , so α = one-third. If A = 1, we have 690 = 12 × L2/3, so L = 436. Then the real wage is 1728 (2/3)690 = 1.06 ≠ 1.15. This is not a long-run equilibrium. Equivalently, if the equilibrium real 436 (2/3)690 wage is 1.15, L must satisfy 1.15 = , so L = 400. Then Y = 12 × 4002/3 = 651.3 ≠ 690. L

This is not a long-run equilibrium. (If the real wage remains 1.15, the quantity demanded of labor will fall to 400. Then, the excess supply of labor will force the real wage to decline to the market equilibrium value of 1.06.) Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking

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38) Suppose that reduced barriers to international financial transactions cause an increase in the economy's supply of capital. Explain, step-by-step, how the economy adjusts to arrive at a new long-run equilibrium. Answer: The increase in the supply of capital (rightward shift of the supply curve) causes an excess supply at the original rental price, and the excess supply causes the price to fall. Since the price of capital falls below its marginal product, firms buy more capital. The increase in capital utilization causes an increase in the marginal product of labor, so the demand for labor increases (the demand curve for labor shifts up). Since the supply of labor is fixed, there is no change in the quantity of labor in use, but the real wage rises to equal the higher marginal product. The rental price of capital stops falling when the quantity of capital in use is equal to the supply of capital. The increase in output is distributed between the capital and labor inputs, so that the share of each factor in total income is unchanged from the original equilibrium. The (unchanged) labor inputs receive a higher wage; each unit of capital receives a reduced payment, but capital's share of total income is increased because of the larger number of capital units receiving payment. Topic: 3.2 Determination of Factor Prices AACSB: Analytical Skills 39) Suppose that a technological advance raises total factor productivity. Explain, step-by-step, how the economy adjusts to arrive at a new long-run equilibrium. Answer: The marginal products of both labor and capital increase, so both demand curves shift up. Since the factor supplies are fixed, there can be no increase in factor utilization, but output has risen, because both factors are more productive. At the original factor prices, there is now excess demand, which causes both the real wage and the rental price of capital to rise. These increases in factor prices distribute the increased output to the inputs, so that the income share of each input in total output does not change. The factor prices stop rising when they are equal to the higher marginal product that results from the improved technology. Topic: 3.2 Determination of Factor Prices AACSB: Analytical Skills 40) Consider an economy in which 350 = 3 × 7000.3L0.7. Calculate the long-run equilibrium values of factor prices and incomes. Answer: Capital's share of income is 30%, so the rental price of capital equals (0.3 ∗ 350)/700 = 0.15. T he quantity of labor input equals



 350    0.3  3  700  

10 / 7

= 54. Labor's share of income is 70%, so the

real wage equal (0.7 ∗ 350)/54 = 4.5. Topic: 3.2 Determination of Factor Prices AACSB: Analytical Skills 3.3 Distribution of National Income 1) There are no questions for this section. Answer:

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