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Macroeconomics
Economics 201
Problem Set # l
Dr. Michele Naples
Spring 1999
l. For each of the following, show graphically whether it implies a shift in a production
possibilities frontier (PPF), a movement along a frontier, or some other result, and explain why.
You must label your axes with the relevant consumer goods, even if the problem concerns
underlying inputs. If the change affects all consumer goods, you may label axes good x and
good z.
a) a decline in the number of high-school graduates who can add.
b) a technical change in home computer production.
c) land is used to produce soy beans instead of wheat.
d) a change in preferences for ice cream instead of whiskey.
e) a decrease in the unemployment rate from l0% to 5%.
f) more records and more clothes are desired.
g) an improvement in glass-processing techniques.
h) an increase in the labor force due to illegal immigrants.
i) a trade embargo is imposed against Iraq.
2. What is a paradigm?
Problem Set # 2
l. If the price indices and median family income for two-earner families in nominal terms for
l973 and l989 are as follow:
l973 price index = 44.4, family income = $l4,256
l989 price index = l24.0, family income = $34,213
a) What was the percent change in nominal family income from l973 to l989?
b) What was the percent change in the price level from l973 to l989?
c) What was real family income in l973?
d) What was real family income in l989?
e) What was the percent change in real family income between l973 and l989?
2. For each of the following, specify whether the person would be counted as employed,
unemployed, or not in the labor force.
a) Someone who quit a good job and has been looking for work in the last 4 weeks.
b) A full-time student who has looked for work in the last 4 weeks.
c) Someone from Newark who gave up looking for work since there are no jobs.
d) A full-time homemaker who looked for work in the last 4 weeks.
3. For each of the following, explain why it does or does not change measured GDP, and in what
direction. Specify whatever assumptions you made, but in general assume common practice.
a) You replace your accountant with your new wife/husband.
b) Buying a used car.
4. What is the value-added approach to the calculation of GDP? (Pick every correct answer)
a) Total expenditures at each stage of the production process are added up to calculate total value
produced.
b) The value of output plus the value of inputs equals total value created.
c) The value of output minus the value of intermediate goods is added up across all sectors.
d) Sum up the value created in each sector over all sectors.
Macroeconomics
Economics 201
Problem Set # 3
Dr. Michele Naples
Spring 1999
1. Suppose for our economy, autonomous consumption is $70 trillion, autonomous spending (Ca
+ I + G + X-IMa ) is $l50 trillion, the marginal propensity to consume is .8, and the marginal
propensity to import is .05.
Aggregate
Expenditure
700
$ trillion
500
300
l00
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|__.__.__.__.__.__.__.__.__.__.__.__ Y
l00 300 500 700 900 ll00
$ trillion
a) Draw the aggregate expenditure curve above, labelling the intercept.
b) Draw the 45o line (along which AE=Ys).
c) Show graphically the equilibrium level of national income.
d) How large is the expenditure-multiplier in this economy?
e) Calculate mathematically the point where AE=Ys (Hint, remember the definition of AE).
f) Suppose we know that for full employment, national income would have to be $800 trillion.
How much would autonomous spending have to increase from its current level in order to
achieve full employment?
2-4: OPEN MULTIPLE CHOICE (more than one answer may be correct)
2. What is the definition of equilibrium in macroeconomics?
a) A situation in which equilibrium price has brought quantity supplied equal to quantity
demanded in all markets.
b) A situation from which there is no tendency to move.
c) Full employment and stable prices.
d) Full employment alone.
3. Why does an increase in aggregate expenditure of $l0 million lead to an increase in national
income of more than $l0 million?
a) Because the mpc is greater than one.
b) Those employed because of the increased demand in turn increase their total consumption,
which leads to higher national income.
c) When aggregate expenditure increases by $l0 million, national income will also only increase
by $l0 million, because AE always equals Y.
d) None of the above.
4. The paradox of thrift implies that
a) if autonomous saving rises, national income will fall and total saving stay the same.
b) an increase in the interest rate will cause increased saving rather than decreased.
c) a lower interest rate will cause decreased saving.
d) saving depends on income and investment, not vice versa.
Macroeconomics
Economics 201
Problem Set # 4
Dr. Michele Naples
Spring 1999
l. Congress has discussed raising taxes or cutting spending to help eliminate the deficit.
a) If lump-sum taxes are raised by $20 billion in an economy with an mpc of .6, what will happen
to national income?
b) Suppose Congress increased defense spending by $l0 billion and cut spending for public
higher education by $l0 billion. What would happen to GDP?
c) What effect would the spending shifts of b) have on future production possibility frontiers and
potential GDP? Why?
d) Some say cuts in welfare, Medicaid and Social Security only decrease transfers, not G, and
therefore do not affect AE or Y. Give a reason why such cuts would also reduce GDP.
2. Given that S = -120 + .1(Y-T), and IM = 10 + .1Y, I = 105, EX = 25, G = T = 150:
a) Calculate the expenditure-multiplier in this economy.
b) What is equilibrium income in this economy?
c) If full employment requires a national income of $1325, how much must government spending
increase to generate full employment?
OPEN MULTIPLE CHOICE:
3. When there are equal changes in government spending and taxation, then GDP will
a) rise by (G)MULT.
b) fall by (mpcT)MULT.
c) rise by (G-mpcT)MULT.
d) remain the same, since the two changes cancel each other out.
4. The money supply serves as
a) the general measure of value in the U.S.
b) the medium of exchange.
c) the unit of account for deferred payments.
d) a store of value.
Macroeconomics
Economics 201
Dr. Michele Naples
Spring 1999
Problem Set # 5
1. Suppose we know that the required reserve ratio is 20 percent, and banks in practice hold an
additional 5 percent of cash reserves against DD.
a) What will be the increase or decrease in the money supply, ceteris paribus, if the Fed buys $l.5
million in U.S. Treasury bills (bonds), for Keynesians? For Monetarists?
b) Explain how the money supply expands or contracts for Keynesians in a), illustrating your
explanation with T-accounts for the first 2 steps of the process. Set up your answer as follows:
A |
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L
1)
2a)
2b)
Totals
A |
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L
A
2c)
3a)
3b)
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3c)
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Subtotal
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Totals
c) If the Fed wants to reduce the money supply by $40 million, and knows the actual money
multiplier is approximately 4, what should it do? Be specific.
2. a) Why is the supply of money vertical for Monetarists?
b) Why is the supply of money upward sloping for Keynesians?
3. Identify all of the following which Keynesians would consider a source of the demand for
money which Monetarists reject or ignore.
a) The Transactions demand.
b) The Precautionary demand.
c) Liquidity Preference
d) The Speculative Demand.
Macroeconomics
Economics 201
Dr. Michele Naples
Spring 1999
Problem Set # 6
1. Compare and contrast Keynesian
i
SM
and Monetarist models of how a $l0
|
million purchase of bonds by the Fed
|
SM
affects the economy. Label the
io |
shifts () and the new equilibrium i, M (*). |
Use graphs to illustrate.
|
DM
|__________________M
Mo
i
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io |
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DM
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|_______________ M
Mo
2. For each of the following, choose whether it would shift the demand for money or supply of
money, in what direction (choose answer A,B,C, or D), and explain why:
A) DM out B) DM in C) SM out D) SM in
a) The Open Market Committee decides to buy bonds.
b) Prices rise.
c) Banks decide to raise their excess reserves.
d) Financiers believe that the riskiness of all financial investments has dramatically decreased.
e) Fearing a recession, precautionary monetary balances increase.
f) The discount rate is reduced by one point.
g) National income falls.
h) The required reserve ratio is increased.
i) Net-worth requirements are increased.
j) More and more financial investors believe the interest rate has to rise.
3. Analyze the effects of the following on currency markets; discuss whether they will shift the
demand for or supply of dollars, and in what direction: A) D$ out B) D$ in C) S$ out D) S$ in
a) Foreigners buy fewer US exports.
b) Foreigners deposit more money in US banks.
c) US consumers buy more foreign imports.
d) US firms deposit less money in foreign banks.
e
S$
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D$
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For 4-5, compare and contrast Monetarist and Keynesian analyses of the effects of the
following on aggregate expenditure and GDP. Which curve initially shifts in which
market? Describe the changes, if any, in i, I, AE, y.
4. The stock market collapses, causing a huge increase in liquidity preference:
A) Keynesian B) Monetarist
5. There is an increase in precautionary holdings by households.
A) Keynesian B) Monetarist
|
SM
io |
i
A
y=AE
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DM
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M
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AE
SM
io | - - |
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'
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io |
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'
I(i)
Ao|
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DM
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'
I
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y
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M
Io
yo
Macroeconomics
Economics 201
Problem Set # 7
Dr. Michele Naples
Spring 1999
1. Suppose there is a decrease in government spending.
a) For Keynesians, describe in words
i) the direct effect on 3 markets (money market, I, AE);
ii) the feedback effect on 3 markets (money market, I, AE).
iii) Combining both the direct and indirect effects, what is the impact of the reduction in G on
GDP? Is there crowding out or crowding in? (Investment is said to be "crowded in" or "coaxed
out" when lower interest rates during the feedback process lead to higher investment).
b) Repeat a), now for Monetarists.
c) What is the hidden assumption necessary for there to be crowding out or in?
d) Does empirical evidence support the validity of this hidden assumption? Explain.
2. P
|AS
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c |
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b
| a
|-----------------|______________________y
a),b),c) Which theoretical model of the graph above explains which segment of the curve?
d) Which segment/theory assumes perfect competition?
3. For each of the following, specify whether PPF shifts or firm costs change, and how AS shifts
as a result:
a) an increase in illegal immigration.
b) a chemical accident that forces the permanent evacuation of a 25-mile area near New York
City.
c) the family leave act (permitting employee to take 3 months unpaid leave to care for newborn
or ill family member) is passed.
d) occupational safety and health laws are relaxed.
Macroeconomics
Economics 201
io
i
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Problem Set # 8
SM
'
'
'
Mo
Dr. Michele Naples
Spring 1999
DM
M
i
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io | - - |
'
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'
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'
Io
I(i)
I
A
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Ao|
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y=AE
AE
y
yo
For 1-3, based on Keynesian assumptions use graphs to describe only the direct effects (do
not graph any feedback effects) on:
a) the money market--does either the supply of money or the demand for money shift,
does the equilibrium interest rate change?
b) investment--shift I(i), or move along I(i)?
c) aggregate expenditure--shift, direction?
d) aggregate demand--shift, direction?
1. Firms become optimistic about future profits.
2. The Congress cuts taxes in an effort to give the economy a jump-start out of the recession.
3. Expecting lower inflation, financiers demand more bonds.
For 4-5, compare and contrast Monetarist and Keynesian analyses of the effects of the
following on aggregate demand, incorporating crowding out/in. Think through what will
happen without drawing the graphs. Which curve initially shifts in which market?
Describe the changes, if any, in i, I, AE, yD, AD.
4. The Kennedy investment tax credit stimulates corporate capital formation.
A) Keynesian B) Monetarist
5. The Fed raises the discount rate: A) Keynesian B) Monetarist
Not to be turned in, but we will go over in class:
6. For each of the following, will it shift aggregate demand or aggregate supply, and in what
direction? Use Keynesian assumptions. Explain what has happened using graphs for
underlying markets as well (e.g., money market, I, AE, PPF, labor market).
a) With the onset of a recession, business confidence evaporates and firms turn pessimistic.
b) New technologies increase productivity.
c) A new flat tax replaces the income tax, drastically reducing the paperwork required of small
businesses.
d) The Fed Chairs announcement of his concerns about accelerating inflation leads to
speculation that the interest rate will rise.
e) Fearing a recession, people try to increase their autonomous saving.
f) The price of oil rises drastically.
g) Banks institute higher capital requirements (net-worth ratio) in the early 1990s:
Macroeconomics
Economics 201
Problem Set # 9
Dr. Michele Naples
Spring 1999
For problems l-2, describe the effect of these changes on aggregate demand and/or supply
for two cases, a) the short run, and b) the long run. Use graphs to illustrate your answer
(see below). Explain why each curve shifts (what happens in the money market, labor
market, etc.). Compare and contrast what happens to the equilibrium level of prices and
output in the two models.
1. Welfare benefits and the taxes which finance them are reduced, leading to an improved work
ethic.
2. Competition from new technologies increases pessimism regarding new investments.
a) P |
AS
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|
Po |- - - |
'
|
'
AD
|_______________________ y
yo
b) P |
AS
|
|
Po |- - - - - - |
|
AD
|______________________ y
yo
3. Describe the disequilibrium adjustment mechanism when either AS or AD shifts: what is the
process whereby P and y adjust to their equilibrium levels? Put differently, why is the change in
output different from the full multiplier effect of the Keynesian-Cross model? [Hint, why are AS
and AD upward/downward sloping for Keynesians, for Monetarists?]
.
Use the graphs below to describe the effects of problems 4-5 for 2 cases:
a) Keynesian AD and short-run AS and the short-run Phillips Curve
b) Keynesian AD and long-run AS, and the long-run Phillips Curve
Explain why either demand or supply and/or the Phillips Curve shift (e.g., what happens in
the money market, labor market, etc.), and what happens to the equilibrium P, y, P, and U.
4. After the stock market crash, the Fed buys bonds to assure the system has plenty of liquidity.
5. Due to the 60s counter-culture, there is a decline in the work ethic.
.
a) P |
AS
a) P |
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. |
Po | - - - - Po | - |
'
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'
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'
AD
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'
Ph
|_______________________ Y
|______________________ U
yo
Uo
b) P |
AS
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Po | - - - - |
|
AD
|_______________________ Y
yo
.
b) P |
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. |
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Po | - - |
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|Ph
|______________________ U
Uo
Macroeconomics
Economics 201
Problem Set # 10
Dr. Michele Naples
Spring 1999
Discuss the political economy theory of why capitalism has business cycles. Explain how
and why the following variables change:
a) capital utilization (capacity utilization)
c) labor productivity
b) wages
d) the profit rate
during the following phases of the cycle:
l. early expansion (U high but falling)
3. early contraction (U rising fast)
2. late expansion (U low)
4. late contraction (U high).
5. To explain the Post-Keynesian theory of the interest rate, discuss changes in the following
factors:
i) Demand for credit
v) Fed policy
ii) Supply of credit
vi) the interest rate
iii) lenders' risk
vii) the profit rate net of
iv) prices/inflation
interest ( - i)
for each of the following phases of the business cycle:
a. early expansion (U high but falling)
c. early contraction (U rising fast)
b. late expansion (U low)
d. late contraction (U high).