[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Review and Practice
SUMMARY
1. Economies experience recessions and booms in which
output fluctuates around its full-employment level.
Recessions are periods in which real GDP declines; in
booms, real GDP increases. The fluctuations in output
are called business cycles.
2. If wages and prices do not adjust quickly enough to
ensure that markets are always in equilibrium, so that
demand and supply are balanced, the economy may
experience fluctuations in cyclical unemployment.
3. To explain cyclical unemployment, we need to explain
why the aggregate labor market does not clear. If real
wages do not adjust when the demand curve for labor
shifts to the left, then the quantity of labor supplied will
exceed the quantity demanded at the prevailing wage
and there will be cyclical unemployment.
4. Wages may be slow to adjust because of union contracts
and implicit contracts that lead to infrequent wage
changes. Firms minimize total labor costs by paying the
efficiency wage. Cutting wages may raise costs by lowering
productivity, as the best workers are most likely to
leave, or by leading to higher labor turnover costs.
5. In the short run, firms adjust production in response to
fluctuations in demand. Thus, aggregate demand plays a
critical role in determining the short-run equilibrium
level of output.
6. Our model of fluctuations will be built around four key
components: (1) wages are sticky, (2) prices are sticky,
(3) there is a trade-off between inflation and cyclical
unemployment in the short run, and (4) inflation and
aggregate spending are linked by monetary policy.
long run
short run
REVIEW QUESTIONS
1. If the labor market always clears, is there any unemployment?
Any cyclical unemployment? What does it mean
for the labor market “not to clear”? What gives rise to
cyclical unemployment?
2. If the labor market always clears, what factors can cause
fluctuations in the level of employment?
3. What inferences can you draw from the following two
facts, assuming that both hold simultaneously?
(a) The labor supply curve is relatively inelastic.
(b) Large variations in employment coexist with
relatively small variations in real wages.
4. What might shift the aggregate demand curve for labor?
5. What are the four key concepts that help explain
economic fluctuations?
6. If cyclical unemployment increases, what would you
expect to happen to inflation? If cyclical unemployment
falls, what would be the effect on inflation?
7. If inflation falls, why will aggregate expenditures rise?
If inflation rises, why will aggregate expenditures fall?
8. What are some explanations for sticky wages?
9. Give three reasons why productivity may depend on the
level of wages paid.
10. How does an efficiency wage differ from a wage that
clears the labor market?
KEY TERMS
recessions
output gap
expansions
peaks
troughs
business cycles
implicit labor contract
efficiency wage
labor turnover rate
PROBLEMS
1. In the 1970s, a large number of new workers entered the
U.S. economy from two main sources. The baby boom
generation grew to adulthood and the proportion of
women working outside the home increased substantially.
If wages adjust, what effect will these factors have
on the equilibrium level of wages and quantity of labor?
If wages do not adjust, how does your answer change? In
which case will unemployment exist? Draw a diagram to
explain your answer. What is the effect of the increased
REVIEW AND PRACTICE ∂ 657