Download Answer Key 3

Homework 3
Economics 503
Foundations of Economic Analysis
Assigned: Saturday, September 23rd, 2006
Due: Saturday, September 30th, 2006
1.
Briefly explain whether the statistics in the following table are consistent with the
economic growth model’s predictions of catch-up.
Ethiopia
China
Madagascar
Ireland
USA
GDP PC 1960
(% of USA)
4.29%
5.55%
10.10%
41.85%
100.00%
Average Growth Rate
In Per Capita
1960-2000
0.47%
4.35%
-1.00%
4.18%
2.53%
We observe a number of the world’s economies having a relatively low level of output per
person in 1960. Some economies such as China or Ireland may have been relatively poor
simply because of a low level of capital per worker. Then, the returns to capital
investment in terms of extra production would be high allowing that country to enjoy high
growth and catch-up with the world leaders. However, if technology or human capital
was relatively low, then we might not see high returns to capital or high levels of growth.
2.
In HK, we observe a sudden, unanticipated increase in consumer confidence. Use
the business cycle model to analyze the effects of this event on output and price
level
a. Draw an AS-AD model and show the short-run effects of this event on the
goods market.
YP
P
P**
SRAS
2
1
´
AD
AD
Y
The aggregate demand curve shifts out as demand rises at every price level. The
effect is to increase production and creating an excess demand for labor.
b. Draw one more graph of the goods market showing the long-term effects of
the rise in consumer confidence showing the self-correction mechanism.
SRAS
P
3
2
P**
1
SRAS
´
AD
YP
AD
Y
The excess demand for labor puts upward pressure on wages then prices shifting
the SRAS until excess demand for labor clears and the economy reaches the
potential level of output.
c. Draw another graph which shows the impact of this event on the loanable
funds market.
r
S
2
rUS$
1
KI
S
I
Loanable Funds
The increase in consumer confidence boosts spending and reduces savings.
Irrelevant This shift in the savings curve means that some fraction of
investment must be financed by capital inflows KI. Some might also suggest if
consumers are more confident they may also buy more residential housing,
boosting investment. This plausible argument suggests that the I curve should
also shift out. This will also work to increase capital inflows.
3.
Stage
1
2
3
4
5
6
Compare two economies, Korea and Japan. In Japan, the marginal propensity to
consume is .75 and in Korea, the marginal propensity to consume is .5. Calculate
the simple closed economy multiplier for both countries. What happens if planned
investment rises by 100 in both countries? Fill in the following table showing the
stages of the multiplier effect. Calculate the sum total of extra expenditure
induced in Japan and Korea after 6 stages.
ΔI
100
0
0
0
0
0
Japan
ΔC
ΔGDP Stage
0
100
1
75
75
2
56.25
56.25
3
42.1875 42.1875
4
31.64063 31.64063
5
23.73047 23.73047
6
328.8086
ΔI
100
0
0
0
0
0
Korea
ΔC
0
50
25
12.5
6.25
3.125
ΔGDP
100
50
25
12.5
6.25
3.125
196.875