Question

Suppose that the Australian economy initially uses 50 billion hours of labor to produce $5 trillion of real GDP. If 50 billion more hours are employed and Australia's real GDP increases by $4 trillion more,

Australia has positive Lucas Wedge.

Australia's production possibility frontier has a positive slope.

Australia's production function exhibits diminishing returns.

Australia's production function exhibits increasing returns.

Australia has an Okun Wedge of $1 trillion.

Answer 1

Solution:

Lucas wedge and okun wedge relates to difference in the actual real output and potential real output. Since, in the question nothing is mentioned regarding potential GDP or output, these options (a) and (e) are rejected.

Production possibility frontier (PPF) gives combinations of different goods that can be produced by employing all available resources and factors of production. So, this option (b) is also irrelevant.

Notice, that question relates a factor of production, labor, to the output produced. It thus, makes sense to think that it has something to do with the production function. Initially, 50 billion of labor hours contributed to $5 trillions, but additional same hours of labor contribute to a lower amount of $4trillions only. So, now additional labor hours are less productive. Clearly, this is possible if Australia's production function exhibits diminishing returns.

So, correct option is (c).