Answer to Question #201007 in Macroeconomics for Kwame Yeboah

Question

1 The sticky wage model of AS:

Select one from the following options:

I. explains the vertical AS in the short run.

ii. assumes flexible prices and nominal wages.

iii. assumes flexible prices and sticky real wages.

iv. explains the short-run deviations of the actual output from the potential one

2 Choose the correct statement:

Select one from the following options.

i. According to the Life-cycle hypothesis the consumption changes only with unexpected changes in income.

ii. Consider the life cycle hypothesis. The human consumption function in the form C = 0.025W + 0.5Y implies that life expectancy is 40 years

iii. Consider the life cycle hypothesis. The human consumption function in the form C = 0.025W + 0.5Y implies that a half of one's life expectancy is spent in retirement

iv. Consider the life cycle hypothesis. The human consumption function in the form C = 0.025W + 0.5Y implies that consumption will increase by CZK 25, when wealth will increase by CZK 1,000.

Answer 1

1.

Keynes criticized the classical economist on the assumption of perfectly flexible prices and wages and argued that in the short run wages are not flexible due to minimum labor laws, wage contracts, labor sentiments etc and thus product and labor market in short run may not clear and there can be divergence between actual output and potential output.

Therefore, the correct option is: explains the short-run deviations of the actual output from the potential one (option - iv).

2.

The Life cycle income hypothesis argues that the individual wage earner adjust its consumption pattern in such a way that it ensures smooth consumption expenditure during all the periods of life.

To ensure smooth consumption the individual saves during the working years of the life and use the saving in the retirement years to maintain the same life style even when the income of the individual is zero.

The consumption function is: C = 0.025 W + 0.5Y

Here, W is wealth and Y is income

Other things being constant, if the wealth of individual increases by CZK1 then the consumption increases by CSK.0.025 so when the wealth increases by $100 then consumption increases by CSK 25.

Correct option is: Consider the life cycle hypothesis. The human consumption function in the form C = 0.025W + 0.5Y implies that consumption will increase by CZK 25, when wealth will increase by CZK 1,00 (option - iv)