Review Questions
Macroeconomics Before the Great Depression

The transparencies for the classical model finish with a fairly thorough review, so we will simply provide a list of questions here. Links go to  answers or hints. Although it is very tempting to do otherwise, you should make a serious attempt to answer a question before following the link. You will learn a lot about your mastery of the material by comparing your answer with mine.  
1. What assumption about the production technology allows us to conclude that the demand curve for labor is negatively sloped?
2. Consider the production function Y=KaL1-a, where 0<a<1. Does the marginal product of labor increase or decrease when the capital stock increases? Show the effect of an increase in the capital stock on employment and output.
3. If there is a sudden increase in the capital stock, what happens to the real rate of interest?
4. In the classical model, explain the effect of a 10 percent increase in the money supply on a) the real rate of interest, b) the nominal wage rate.
5. Why do we say that any measured unemployment can only be interpreted as voluntary unemployment in the classical model?
6. Within the classical framework, show the effect on the price level of introducing an income tax to be paid by workers.
7. Within the classical framework, show the complete effects on the macroeconomy of introducing a payroll tax to be paid by employers.
8. The government decides to impose a tax on the interest earnings of savers. Show the immediate effect of the new policy on a) the savings-investment equilibrium, b) on employment. c) What will be the long term effects on employment?
9. What circumstances make it more likely that an increase in the marginal income tax rate will reduce rather than increase government revenue?
10. How does the classical model make a theory of inflation out of an accounting identity?
11. What is an accounting identity? Provide some examples from material we have studied so far. Distinguish an accounting identity from a behavioral equation.
12. Economists in Cambridge, England, thought that the quantity theory of money was a too mechanical as an explanation of money demand. Explain their version of the money demand equation.
13. The quantity theory of money assumes that the velocity of circulation can safely be assumed to be constant at all points in time. Is it reasonable to assume constant velocity even through booms and recession? If velocity is not constant, what implication does this have for the classical theory of inflation?
14. Explain the concept of crowding out.
15. How would one go about evaluating how important crowding out is? What difficulties might one encounter?
16. "It does not matter whether government expenditure crowds out investment or not. In either case, less government expenditure is good." Explain, from the perspective of the classical model.
17. What causes of economic fluctuations are consistent with the classical model?
18. In what way did the classical model fail to provide an adequate explanation of the Great Depression?