19Chapter-Mankiw - Questions for Review 1. Real business...

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Unformatted text preview: Questions for Review 1. Real business cycle theory explains fluctuations in employment through fluctuations in the supply of labor. The theory emphasizes that the quantity of labor supplied depends on the economic incentives that workers face. Intertemporal substitution—that is, the willingness of workers to reallocate their labor over time—is especially important in determining how people respond to incentives. If today’s wage or interest rate is tem- porarily high, for example, it is attractive to work more today relative to tomorrow. 2. There are four central disagreements in the debate over real business cycle theory. These disagreements have not yet been settled, and, as a result, they remain areas of active research. These areas are: i. The interpretation of the labor market. Over the business cycle, the unemploy- ment rate varies widely. Advocates of real business cycle theory believe that fluc- tuations in employment result from changes in the amount people want to work— by assumption, the economy is always on the labor supply curve. They believe that unemployment statistics are difficult to interpret for at least two reasons: first, people may claim to be unemployed to collect unemployment-insurance benefits; second, the unemployed might be willing to work if they were offered the wage they receive in most years. Critics think that fluctuations in employment do not just reflect the amount that people want to work. They believe that the high unemployment rate in reces- sions suggests that the labor market does not clear—that is, that the wage does not adjust to equilibrate labor supply and labor demand. ii. The importance of technology shocks. Real business cycle advocates assume that economies experience fluctuations in their ability to produce goods and services from inputs of capital and labor. These fluctuations may arise from the weather, environmental regulations, and oil prices, as well as technology itself. Critics of real business cycle theory ask, “What are the shocks?” It seems likely to them that technological progress occurs gradually. Also, these critics question whether recessions are really times of technical regress. The accumula- tion of technology may slow down, but it seems unlikely that it goes into reverse. iii. The neutrality of money. Reductions in money growth and inflation are usually associated with periods of high unemployment. Most observers interpret this as evidence that monetary policy has a strong influence on the real economy. Real business cycle theory focuses on nonmonetary (that is, “real”) causes of business fluctuations, arguing that the close correlation between money and output arises because fluctuations in output cause fluctuations in the money supply, not the reverse. Hence, advocates of real business cycle theory argue that monetary policy does not affect real variables such as output and employment....
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This note was uploaded on 02/22/2012 for the course ECON 602 taught by Professor Smith during the Spring '12 term at FSU.

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19Chapter-Mankiw - Questions for Review 1. Real business...

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