1. The classical model assumes that the marginal product of labor declines as additional labor is used. Suppose this were not true suppose the marginal product of labor were constant. How would the behavior of the system be different? Would it still have a definite equilibrium? Why or why not?

2. For each of the following cases, explain what the classical model predicts will happen to output, employment, wages, the interest rate, and the price level. (The answers might be no change or indeterminate, as well as increase or decrease.) Either clearly explain the full set of causal links, or show them in diagrams.

a. A positive supply shock: technological improvements raise the productivity of labor.

b. A positive supply shock: the labor supply increases (e.g. thanks to an increase in the fraction of the population looking for paid work).

c. A cut in the tax on profits (i.e. on income from investment).

3. Suppose there is, for whatever reason, an increase in the level of investment desired by business. For each of the two models (classical and Keynesian), say what will be the effect on the interest rate, consumption, the money stock, and employment.

4. In the Keynesian vision, a typical recession might develop like this: problems in the financial system lead to a decrease in the supply of money (or liquidity). This leads to higher interest rates, which discourage investment. As a result, output falls, leading to higher unemployment.

The classical model is said to offer a "triple defense" against the possibility of this kind of unemployment. What are the three features of the model that could prevent unemployment from developing in this scenario? Explain how each works, what source(s) of unemployment it protects against, and what happens instead of a rise in unemployment.