Download Macro2 Exercise #2 Answers

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Macro2 Exercise #2 Answers (
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Please limit your answers to the spaces provided. If necessary, write on the back of the page.
Do not attach printout or additional pages. All questions pertain to the Macro2 module in the
SimEcon® software package.
Make sure that you have read the “Macro2 Manual” and SimEcon® Operation Instructions.”
These materials may be found at the Class Web site prior to beginning the exercise. For many
of the exercise’s questions, it will be necessary to refer to those instructions. For many of the
exercise’s questions, it will be necessary to refer to your text.
Open the Macro2 module. You will see a table entitled, “State of the Macroeconomy.” Select
the button entitled, “Recession” and click to make inflationary expectations constant. After that,
click “Continue.” You will see a table entitled, “Initial Conditions: Recession.” Print out this
table for future reference. Click “Continue.” You will see a table entitled, “Policy Decisions.”
You are stuck with the original values of G = 600, T = 600 and MS = 60 set by the previous
administration, so just click “Calculate.” This will give you the initial conditions again. Other
things being equal, and if the recession was the only concern, it would be wise to increase
(increase, decrease, leave unchanged) government spending, decrease (increase, decrease,
leave unchanged) taxes and increase (increase, decrease, leave unchanged) the money supply.
Now, click “Next Year.” Enter the following amounts: G = 580, T = 620 and MS = 59. Click
“Calculate.” Is this administration running a budget deficit, a budget surplus or neither? This
administration is running a budget surplus.
What has happened to real GDP? It has gone down. What has happened to the unemployment
rate? It has gone up. What has happened to inflation? It has gone down.
What has
happened to the real interest rate? It has gone down. What is the difference between the real
and the nominal interest rate? The real rate tells the return, corrected for expected changes
in purchasing power, that people expect on their savings. It is also the real cost firms expect
if they borrow to finance investment. The nominal rate is the one everyone sees, but it
does not tell expected returns or costs. The real interest rate equals the nominal interest
rate less inflationary expectations. If the recession was the major concern of the government,
do you think that this was a wise policy? No (Yes, No). Why or why not? Real GDP went
down and unemployment went up. These policies caused the recession to get worse.
Click “Next Year.” This time, enter the following amounts: G = 660, T = 570, MS = 65. Click
“Calculate.” Is this administration running a budget deficit, a budget surplus or neither? This
administration is running a budget deficit. Fill in the amounts in the table below:
Real GDP: $2,366.67
Unemployment Rate: 2.90%
Inflation Rate: 9.26%
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Macro2 Exercise #2 Answers
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Compared to the last example, what has happened to real GDP? It has gone up. Likewise,
what has happened to the unemployment rate?
It has gone down. Likewise, what has
happened to inflation? It has gone up. Given that the economy was in a recession, did this
seem like a wise policy? Yes (Yes, No). Would everyone agree that inflation at an acceptable
level? No, most people would not consider this an acceptable rate (Yes, No). Explain why
this would or would not be considered an acceptable inflation rate. People who had lent
money expecting the previous inflation rate would not like the new rate. The real rate they
expected was greater than the real return they got. Debtors would have a different
opinion. There would be considerable costs due to greater need to search markets
(obsolescence of old price data). There would be additional costs of actually implementing
the price changes. Click “AS + AD Graph.” Draw the resulting graph below:
Click “AD + AS Graph.” Draw the resulting graph below. Indicate the aggregate supply curve,
the aggregate demand curve, and the full employment output and label all axes.
P
AS
AD
GDPFE
GDP
Is this economy at full employment, below full employment or above full employment? This
economy is above full employment. How can you answer this question using the above graph?
The economy represented by the above graph is at a short run equilibrium where the AS
and AD curves intersect. However, the full employment level of income, indicated by
GDPFE, is to the left of current income so current income is above full employment. Is it
possible for an economy to be above full employment? Yes (Yes, No). If so, how is this
possible? People could be working a lot of overtime when in the long run they would not
want to work overtime. Elderly people could be drawn into short term employment.
Young people could take jobs although they will eventually go back to school.
Click the “Back” button once. If this society was dissatisfied with an unemployment rate of
even 2.90% the government should increase (increase, decrease, leave unchanged) government
spending, decrease (increase, decrease, leave unchanged) taxes and increase (increase,
decrease, leave unchanged) the money supply. Click “Next Year.” Enter the following amounts:
G = 680, T = 550 and MS = 67. Click “Calculate.” Is this administration running a budget
deficit, a surplus or neither? This administration is running a budget deficit.
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Macro2 Exercise #2 Answers
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Fill in the amounts in the table below.
Real GDP: $2,458.15
Unemployment Rate:
1.08%
Inflation Rate:
94.49%
Has this society virtually succeeded in eliminating unemployment? Yes (Yes, No). Has real
GDP increased above the last example? Yes (Yes, No). What was the major cost of this
policy? This policy caused a near hyper-inflation rate of 94.49%.
What are the problems with such a high inflation rate in terms of inflationary expectations?
With such a high inflation rate, inflationary expectations become embedded into the
system, so the inflation perpetuates itself. What are the potential problems of such a high
inflation rate in terms of people on fixed incomes, and how does this relate to the indexing of
benefits? If a pension or benefit is indexed for inflation, there is no problem. However, if
a pension or benefit is not indexed the beneficiary will suffer a sharp drop in his or her
standard of living because the same nominal income will be able to buy much less in terms
of goods and services. How can such a high inflation rate potentially cause a redistribution of
income in terms of creditors versus debtors and how does this question relate to the indexing of
loans? If the loans are indexed for inflation, there is little or no redistribution of income.
If the loans are not indexed for inflation, then debtors will gain at the expense of the
creditors because the debtors will pay off their loans in dollars that can buy less in terms of
goods and services.
Other than redistribution and other matters than can be “fixed” by
indexation, are there reasons to avoid inflation? Yes (Yes, No). Explain why or why not?
Inflation has other costs including those caused by uncertainty over prices—people in
markets cannot tell whether a given current price is a “good deal” or not based on past
price information. That means more time spent in search, in both resource and final goods
markets. It also is costly to change prices often. All in all, did this last example provide an
example of sound economic policy? No (Yes, No). Why or why not? This policy virtually
eliminated unemployment, but the potential costs and problems of inflation are too high.
Click “New Term in Office.” This time, select “Inflation” as the state of the macroeconomy
and click below that button to make inflationary expectations constant. Click “Continue.” You
will see the table titled, “Initial Conditions: Inflation.” Click “Continue.” You will see “Policy
Decisions.” Click “Calculate.” This will give the same results as “Initial Conditions: Inflation.”
Other things being equal, if inflation was the only concern, it would be wise to decrease
(increase, decrease, leave unchanged) government spending, increase (increase, decrease, leave
unchanged) taxes and decrease (increase, decrease, leave unchanged) the money supply.
Now, click “Next Year.” Enter the following amounts: G = 750, T = 540 and MS = 63. Click
“Calculate.” Is this administration running a budget deficit, a budget surplus or neither? This
administration is running a budget deficit. A message appears. What does the message say?
The message says, “You have exhausted the patience of the population. They are sick of
hyperinflation and you are gone!” In this example, what inflation rate did we start with?
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8.12%. What caused this hyperinflation? We already started with a relatively high inflation
rate. Pursuing a policy of increasing government spending, reducing taxes and increasing
the money supply was the exact opposite of what we should have done. This policy only
served to exacerbate the inflation that already existed. What levels of inflation have South
American nations such as Brazil and Argentine experienced at various times during the last
several decades? They have experienced inflation rates over 500%.
Click “OK.” You will arrive back at the the “State of the Macroeconomy.” Select inflation as
the state of the economy and click to make inflationary expectations constant. Click “Continue”
and on the “Policy Decisions” screen click “Calculate.” This will give the same results as
“Initial Conditions: Inflation.” Fill in the amounts in below.
Real GDP:
$2,315.03
Unemployment Rate:
3.93%
Inflation Rate:
8.12%
Click “Next Year.” This time, enter the following amounts: G = 680, T = 700 and MS = 58. Is
this administration running a budget deficit, a budget surplus or neither? This administration
is running a budget surplus. Click “Calculate.” Fill in the amounts in the table below:
Real GDP:
$2,300.02
Unemployment Rate:
4.23%
Inflation Rate:
7.37%
Has this policy succeeded in reducing inflation? Yes (Yes, No). What are some of the
disadvantages of this policy? Real GDP has fallen slightly and the unemployment rate has
increased slightly. What is the relationship between inflation and unemployment? There is a
trade-off between inflation and unemployment. If a government pursues a policy to reduce
inflation, what is likely to happen to unemployment? Unemployment will rise. Likewise, if the
government pursues a policy to reduce unemployment, what is likely to happen to inflation?
Inflation will rise.
Click “AS + AD Graph” and draw the resulting graph below. Indicate the aggregate supply
curve, the aggregate demand curve, the full employment output and label all axes.
P
AS
AD
GDPFE
GDP
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Macro2 Exercise #2 Answers
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Is this economy above, below or at full employment? Above (less unemployment than at full
employment). Do a significant number of economists consider an unemployment rate that is at
or below 4% to be “acceptable”? No (Yes, No).
Starting from a balanced budget, if the administration wants to control inflation, should the
government move toward run a budget surplus or a budget deficit? The government should
move toward a budget surplus. Likewise, should the government increase or decrease the
money supply? The government should decrease the money supply.