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ECON 104 HOMEWORK #1 (75 points total)
1. (40 points total – 5 points each part, 10 points for correct and completely
labeled diagram) Suppose the consumption function is as follows:
C = a1 Yd + a2 WRE/S + a3CC
Where all the a’s (the sensitivity parameters) are greater than zero.
Initial conditions: Let a1 = 0.60, a2 = 0.04,
a3 = .5, WRE/S = 18,000: CC = 90
1. a) Solve for C in terms of Yd and graph the consumption function.
2000. b) Let Yd = 2000…. solve for the level of consumption and label as
point A on your diagram.
100.
c) Now suppose disposable income falls due to a tax increase (Uncle
Sam is trying to balance the budget) to 1800 but at the same time, the
stock market rallies so that WRE/S rises to 22,000 and along with it,
consumer confidence (CC) rises to 100. Re-solve for C in terms of Yd.
1. d) Solve for the level of consumption given the change in part c) and add to
your diagram as point B.
1. e) Now show as point C, the level of consumption that would have occurred
if Uncle Sam did not raise taxes (we still had the same change WRE/S and
CC as in part c)).
1. f) What is the percent change in consumption from points A to B?
2. (30 points – 10 points each part) In this problem, we are going to obtain
data on consumption and disposable income from the Federal Reserve.
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


Go to FRED (Federal Reserve Economic Data) and search for PCECC96 (real
personal consumption expenditures – this is consumption)
Record the level of consumption the quarter that you were born as well
recording the most recent data on consumption.
Search FRED again for DPIC96 (real disposable personal income – this is
disposable income (Yd))
Record the level of disposable income the quarter you were born as well as
the most recent data on disposable income. Please answer the following
questions.
1. a) What is the percent change in consumption since you were born? What
is the percent change in real disposable income since you were born?
Please show all work.
1. b) Draw a graph, much like you did on question #1, with disposable income
(Yd) on the horizontal axis and consumption on the vertical axis, plotting as
point A the disposable income / consumption combination when you were
born and plotting as point B, the most recent disposable income /
consumption combination.
1. c) Would it be correct to connect points A and B with a ruler and call it a
consumption function? Why or Why not (don’t actually do it)?
3) (5 points) Solve the following equation for Y
ECON 104 HOMEWORK #2 (75 points total)
1. (25 points) Suppose South Korea can produce 100 computer chips with 10
hours of labor input and 50 bed linens with 6 hours of labor input.The US
can produce 100 computer chips with 8 hours of labor input and 50 bed
linens with 4 hours of labor input.
1. a) What is the opportunity cost of producing 100 computer chips for South
Korea?
1. b) What is the opportunity cost of producing 50 bed linens for South Korea?
1. c) What is the opportunity cost of producing 100 computer chips for the
US?
1. d) What is the opportunity cost of producing 50 bed linens for the US?
1. e) Using comparative advantage, which country should import bed linens?
Why?
2. a) (5 points) If free trade is so good why do some people complain? Give a
specific example and please refer to the Dub – Chud example. Be sure to be
clear and explicit about the ‘complainers’ and why they are complaining.
Pl provide notes for this as it refers to some text material
1. b) (5 points) Name two groups that typically protest at WTO (World Trade
Organization) meetings.
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
Peoples’ Global Action: ‘a worldwide alliance of organizations and
grassroots movements with representatives of grassroots movements in 56
countries.
Greenpeace
3. (10 points) In three sentences or less, explain exactly what it means to say
“there is no such thing as a free lunch.”
4. (5 points) Suppose that I make $15 per hour and you make $20 per hour
and we both like to eat hamburgers that cost $5 each.Compare my real
wage (in terms of hamburgers) to your real wage.
5. (10 points) Give an example of a decision that is rational ex-ante but
irrational ex-post. Under what conditions will this rationality be different
and under what conditions will this rationality (ex-ante and ex-post) be the
same.
6. (5 points) Using marginal analysis, explain how you would determine how
much to eat at an all you can eat restaurant.
7. (5 points) Go to the index of economic freedom and identify which of the
ten “freedom” criteria the United States does best on (in terms of
economic freedom) and which of the ten criteria does the United States
score the worst in terms of economic freedom.
8. (5 points) Write down a normative economic statement and a positive
economic statement.Explain in detail, what the difference is when
comparing normative and positive economic statements.
ECON 104 HOMEWORK #3 (75 points total)
1. (20 points) Consider an economy that produces only two goods: fresh
apricots and dried apricots. In this economy, the technology of producing
dried apricots is to place fresh apricots on special racks and allow them to
dry in the sun. Fannie’s Farms is the only company that grows fresh
apricots, while Darryl’s Dried Victuals is the only producer of dried apricots.
Fannie’s sells some of its apricots directly to consumers for consumption.
The relevant revenue and cost information for each of the two firms in the
economy is given below:
Darryl’s
Revenue from selling dried apricots:
$2,300,000
Cost of buying fresh apricots from Fannie’s:
1,200,000
Interest on funds borrowed to buy drying racks:
Wages paid to employees
Taxes
250,000
600,000
100,000
Fannie’s
Revenue from selling fresh apricots:
Rent on land (including apricot trees)
Wages to employees
Taxes
$2,000,000
300,000
1,200,000
200,000
Calculate nominal GDP using the expenditure approach and the income approach
and show that they give the same answer.
2. (15 points) According to the cruise ship example:
1. a) what are the real and what are the nominal objectives (goals) of
macroeconomic policymakers?
1. b) what are the three policy lags and how do they differ with regard to
fiscal vs. monetary policy?
1. c) go to FRED and search for UNRATE and compare the most recent
unemployment rate to the rate associated with full employment as defined
by the series NROU on FRED. Note that NROU is quarterly data so match
the quarter with the most recent unemployment statistic. Which is higher
and in terms of policy, should policymakers try to stimulate the economy or
should they try to slow it down?
3. (20 points)Use the table below to answer the following questions (please
show all work).
Good
2011
2012
Quantity Price
Quantity Price
Tomatoes 500
$2.00
600
$2.20
Tofu
800
$4.00
1000
$4.25
Tacos
900
$3.00
900
$4.00
1. a) What is nominal GDP for 2011?
1. b) Assuming that 2011 is the base year, calculate real GDP in 2011
1. c) Now calculate the GDP deflator for 2011 and 2012 (assuming that 2011 is
the base year).
1. d) What is the rate of economic growth between the two years as defined
byt he percent change real GDP.
1. e) What is the rate of inflation between the two years?
4. (10 points) Go to FRED and search for GDP (nominal GDP) and GDPDEF (the
GDP price deflator) and using the most recent data, use these two series to
calculate real GDP. Now search for GDPC1 (real GDP) and verify that your
answer is correct.
5. (10 points) Go to the NBER website and using the official dates of the 1973
– 1975 recession (from peak to trough) calculate the percent change in real
GDP (GDPCI from above) and the percent change in the GDP price deflator
(GDPDEF from above) during the recession. What is this combination of
GDP growth and percent change in prices referred to and why?
ECON 104 HOMEWORK #4 (110 points total)
1. (25 points – 5 points each part)
On the Colbert Report, March 17, 2008, Stephen Colbert makes fun of the fact that
the unemployment rate fell even though less people are working (feel free to
Google it). Using the formula for the unemployment rate, show how this, the idea
that the unemployment rate can fall even though less people are employed, is not
as unusual as one may think. Be specific as to what happens, exactly, to the
numerator and the denominator of the unemployment rate expression.
We are now going to use real economic data to confirm that this phenomenon, the
fact that the unemployment rate can fall along with the employed did occur just as
Stephen Colbert said. Stephen was referring to the one month change in the
unemployment rate between January and February 2008.
1. Go to FRED and using the series UNRATE, confirm that the unemployment
rate did fall between these two months (simply report the statistics from
FRED)
1. Using FRED again, search for NPPTTL (these are payrolls – the number of
people working) and confirm that payrolls did decline between these two
months.
1. Finally, using FRED once again, search for UNEMPLOY (the number of
people unemployed) and confirm that your reasoning in part a) above was
correct.
1. Suppose you are talking with someone, call her Mary, shortly after this
particular report came out. Mary was trying to convince you that this
report, showing that the unemployment fell between January and February
2008, clearly indicates that labor market conditions are getting better.
Given that you know the facts, give Mary two specific reasons that suggest
that labor market conditions are getting worse rather than better.
2. (20 points total, 5 points each part) The table below shows the
‘hypothetical’ basket(s) of consumption goods for a ‘typical’ Penn State
college student for 2012 and 2013. Answer the following questions using
the information in the table.
2012 Basket for ‘typical PSU college
student’
Item
Textbooks
Rent
Price
Quantity
$80
6
$700
PSU sporting
events
$15
Dinners in
State
College
$25
2013 Basket for ‘typical PSU college
student’
Item
Price
Quantity
Textbooks
$90
6
1
Rent
$800
1
6
PSU sporting
events
$20
3
6
Dinners in
State College $25
8
1. Calculate the rate of inflation between 2012 and 2013 assuming 2012 is the
base year. Please show all work. Note, calculate the rate of inflation using
price indexes.
2013. Now update the base year to 2013 and recalculate the rate of
inflation between 2012 and 2013. Again, show all work! Calculate the rate
of inflation using price indexes.
1. Which rate of inflation accounts for the substitution bias? In your answer,
identify and explain why, using relative prices, the substitution that this
PSU college student rationally made.
1. Calculate the ‘Chain Weighted’ rate of inflation (again, show all work).
Pl provide notes for this
3. (10 points) Discuss the problems associated with using the unemployment
rate as a gauge of labor market conditions. In your answer, make sure you
mention how underemployment, discouraged workers, and working under
the table play a role in terms distorting the signal that we would want the
unemployment rate and changes in the unemployment rate to send in
terms of labor market conditions.
4. (5 points) Go to FRED and search for UNRATE (the unemployment rate) and
NROUST (NAIRU) and using the most recent available data, compare the
two. How much and in what direction would the actual unemployment rate
have to change to get us to full employment = NAIRU? Note that NROUST is
quarterly data so simply use the quarter that includes the month of the
most recent UNRATE statistic.
5. (25 points total) In this problem we are going to calculate real interest
rates, both ex-post and ex-ante. The data you need for this problem are
given in the links below:
1. (10 points) Calculate the ex-ante and ex-post real rate of interest between
June 2008 and June 2009 (note that June 2009 is the last month of the
Great recession – the official recovery, began in July of 2009). Why are
these real rates so different? Again, please show all work.
2009. (10 points) We know that most decisions are in part, based on
expectations of the future. Suppose we have two people who are trying to
decide whether to consume today (assume it is currently June 2008) or
save for the future and consume one year later, in June 2009. One person,
let’s call him Joe, is basing their decision on the ex-ante real rate of interest
like most of us do. The other person who has a crystal ball, we’ll call her
Crystal, can see exactly what the actual rate of inflation is going to be and
thus, has perfect foresight and bases their decision on the ex-post real rate.
Given the difference in the ex-ante and ex-post real rates above, who
would be more likely to save and who would be more likely to spend?
Explain in detail and feel free to use the shopping cart example we used in
lecture.
1. (5 points) Given your response in part b) above, is the behavior of either
Joe or Crystal consistent with the ‘evils’ of deflation? Why or why not.
Explain.
6. (15 points total) Use the information in “Study shows costs of living for
working families leveling off in Pa.” to answer the following questions:
1. (5 points) Using Allegheny county as the base county, what is the price
index in Centre county? In Chester county? Please show your work.
1. (10 points) If you are currently making $75,000 per year in Centre county,
how much would you need to make in Allegheny county to have the same
real purchasing power as you have in Centre county? Answer the same
question for Chester county (i.e., how much do you need to make in
Chester county to have same purchasing power as you do with $75,000 in
Centre county).
7. (10 points) A friend of mine came to Penn State in the 1970s and told me
that sticky buns at the College Diner cost $.75 (75 cents) in December of
1976. Using the CPI and assuming that the price of sticky buns rose in exact
proportion to the CPI, what would the current price of sticky buns have
now so that the ‘real price’ of sticky buns remains constant. Use the most
recent available data for the CPI and please show work.
ECON 104 HOMEWORK #5 (100 points total)
1. Initial Conditions (25 points total)
Consider a firm that has the following relationship between labor and output,
i.e., a production function. Along this production function, we hold land,
capital (K) and technology (total factor productivity) fixed. Fill in the
following table (5 points).
TABLE 1
L
Q
MPL
MRP
Marginal Profit Total Profit
0
0
–
–
–
1
8
2
20
3
28
4
35
5
41
6
45
0
The current wage is $150 and the price of output (Q) = $20.[1]
1. (5 points for i through iv)
1. The profit maximizing output is _______.
1. The profit maximizing level of labor input is ________ workers.

The maximum profit for this firm is __________.
1. What is the marginal revenue product of the 6th worker? ___________
1. (10 points for correct and completely labeled diagram with points A,
B, C, D) Draw the production function associated with the table
above. Note, labor (L) is the variable on the horizontal axis and
output (Q) is the variable on the vertical axis and locate this initial
point as point A.
1. (5 points) Now draw the W / MRP labor market diagram (associated with
Table 1 above) as we did in lecture being sure to be clear on the areas that
represent labor costs, MRP, and the marginal profit or loss – use the
“smoothed out version” rather than the barchart version (use different
colors if at all possible). You will need to draw a total of three of these
‘initial conditions W / MRP labor market’ diagrams (point A).
Be sure to watch the Homework 5 Explanation video in the Homework 5
folder in ANGEL for some guidance on the rest of the Homework
Assignment.
We are now going to consider 3 different scenarios. We treat each scenario as
independent events. You will start off with a new W / MRP labor market diagram
for each scenario with these same initial conditions. Specifically, we start at point
A and then depict and explain what happens when we go from scenario to scenario,
much like we did in the lectures. That is, once we evaluate each scenario, we
return back to the original conditions and then consider the next scenario.
1. Scenario # 1: (25 points total).
Suppose that due to favorable economic conditions, the price that this firm
can sell its product for rises to $22. Fill in the following table. Solve for the
new profit maximizing output and profit (5 points).
TABLE 2
L
Q
MPL
MRP
Marginal Profit Total Profit
0
0
–
–
–
1
8
2
20
3
28
4
35
5
41
6
45
0
The current wage is $150 and the price of output (Q) = $22.
1. (5 points for i through iii)
1. The profit maximizing output is _______.
2. The profit maximizing level of labor input is ________ workers.

The maximum profit for this firm is __________.
1. Locate this change in conditions as point B on the production function you
drew in part 1b above.
2. (10 points for correct and completely labeled diagram with points A, B, C,
and D) Now construct a supply curve as we did in lecture with point A
representing the original price – output combination and point B
representing the price – output combination after the change in economic
conditions (after price rises to $22).[2] Make sure you label the graph
completely including what we hold constant along the supply curve. Note,
you will be adding points C and D to this diagram.
Given the change in prices, identify point B on your W / MRP labor market
diagram that you drew in part 1c. Be sure to completely label your diagram
as we do in the lectures.
3. (5 points) Explain exactly why the firm changes their behavior (hint, it might
help to consider what the difference would be if they did not change their
behavior).
1. Scenario # 2 (20 points total)
We return to the original conditions and now we let wages change. In
particular, let an increase in labor supply lowers the wage that the firm needs
to pay to $130. Fill in the table below (5 points).
TABLE 3
L
Q
MPL
MRP
Marginal Profit Total Profit
0
0
–
–
–
1
8
2
20
3
28
4
35
0
5
41
6
45
The current wage is $130 and the price of output (Q) = $20.
1. (5 points for i though iii)
1. The profit maximizing output is _______.
2. The profit maximizing level of labor input is ________ workers.

The maximum profit for this firm is __________.
1. Locate this change in conditions as point C on the production function you
drew in part 2b above.
2. (5 points) Explain exactly why the firm changes their behavior (hint, it might
help to consider what the difference would be if they did not change their
behavior).
(5 points) Re – draw the W / MRP labor market diagram depicting initial
conditions (i.e., point A) and now add the new conditions given the lower wage as
point C.
Now add point C to your supply curve diagram (don’t draw a new diagram) that
you drew in part 2b), being sure to label diagram completely.
[1] Note, we are assuming, as we did the lectures, that the firm is small relative to
the market so that the firm is a price taker in the marketplace and the labor market.
Put differently, the firm can sell as much as they want at the market (given) price
(P = $20) and hire all the labor it wants at the given wage (W = $150).
[2] We follow the lecture by identifying two points (A and B) and then connect the
dots with a ruler implying a linear supply curve. Even though this is probably not
the case, the idea is to understand exactly why the supply curve slopes upward and
not to worry about whether the slope is constant or not.
ECON 104 HOMEWORK #6 PART 1 and 2
Suppose the initial conditions of the economy are characterized by the following
equations in black font. We then shock the economy as shown in the red font.
1) C = a0 + a1 (Y-T) + a2 (WSM) + a3 (WRE) + a4 (CC) + a5 (r)
1’) C = a0 + a1 (Y-200) + a2 (10,000) + a3 (15,000) + a4 (120) + a5 (4)
1’’) C = a0 + a1 (Y-200) + a2 (12,000) + a3 (15,000) + a4 (160) + a5 (4)
2) I = b0 + b1AS + b2CF + b3 (r)
2’) I = b0 + b1 (140) + b2 (1500) + b3 (4)
2’) I = b0 + b1 (180) + b2 (2000) + b3 (4)
3) G = G
3’) G = 200
4) X-M = X-M
4’) X-M = -200
4’) X-M = -400
5) AE = C + I + G + X-M
Where: a0 = 50, a1 = .60, a2 = .05, a3 = .10, a4 = .5, a5 = -400, b0 = 100, b1 = .5, b2
= .2, b3 = -50
1. a) (20 points total – 5 points for expression and 15 points for correct and
completely labeled diagram). Given the initial conditions, find expression
for consumption function and provide a completely labeled diagram. Please
show all work.
1. b) (20 points total – 5 points for expression and 15 points for correct and
completely labeled diagram). Given the initial conditions, find an expression
for the aggregate expenditure curve (AE in terms of Y), solve for equilibrium
output and provide a graph of this aggregate expenditure curve labeling
this initial equilibrium as point A. Please add point A to your consumption
function diagram, being sure to label this point completely. Please show all
work.
1. c) (10 points) We now incur shocks as provided in red font. Solve for a new
expression of the consumption function and aggregate expenditure curve,
solve for the new equilibrium output and add this new equilibrium point to
both of your diagrams (label as point B). Please show all work.
1. d) (10 points) Are your results consistent with the new economy? Why or
why not? Explain in detail.
Part 2: True / False Questions (2 points each – 40 points total) Answer T for True
and F for False
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Consumption is positively related to stock market wealth but negatively
related to taxes and tax rates.
If aggregate expenditures rise unexpectedly, then inventories will also rise
unexpectedly.
Services are the most interest rate sensitive component of consumption.
Investment is the most cyclical component of aggregate expenditures.

The ‘job-loss’ recovery occurred following the 2001 recession.

Negative real interest rates imply that if you save today, you can purchase a
smaller basket of goods and services in the future, relative to the basket
you could have consumed today.
The higher the marginal propensity to consume the more powerful tax
policy is to influencing consumption.
According to the results of the estimated consumption function,
consumption is more sensitive to changes in stock market wealth relative
to changes in real estate wealth.
The sensitivity parameter in the consumption function that measures how
sensitive consumption is to changes in consumer confidence is referred to
as the marginal propensity to consume.
In a consumption function with income (Y) on the horizontal axis and
consumption (C) on the vertical axis, a fall in the real rate of interest (all
else constant) will cause a shift upward of the consumption function.
In a consumption function with income (Y) on the horizontal axis and
consumption (C) on the vertical axis, a rise in the price level (all else
constant) will cause a shift upward of the consumption function.
A fall in tax, the effective tax rate on capital will result in the investment
demand function shifting to the right.
The slope of the investment demand function indicates how sensitive
investment is to changes in real interest rates. The ‘flatter’ the investment
demand function, the less sensitive investment is to changes in the real rate
of interest, all else constant.
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A rise in imports, all else constant, will increase net exports.
If the US is growing faster than the rest of the world, then all else constant,
the trade deficit will widen (get more negative assuming we were running a
trade deficit to begin with).
If the inflation rate rises in China so that it exceeds that of the US, then net
exports for the US should increase, all else constant.
If the exchange rate between the US dollar and Japanese yen changes from
$1 = 100 yen to $1 = 80 yen, then US exports to Japan will become more
expensive to Japanese importers.
We argued that cash flow (CF) increased during the Great Recession and
thus, had a positive effect on investment.
In a consumption function with income (Y) on the horizontal axis and
consumption (C) on the vertical axis, a rise in stock market wealth, all else
constant, will result in a movement along the consumption function.
The stronger the US dollar is relative to the rest of the world, all else
constant, the larger the net exports in the US.
ECON 104 HOMEWORK #7 Part 1 and 2
PART 1 : Pretend that you have a lemonade stand and that the demand for
lemonade in your neighborhood is estimated to be:
Q = 60 – 100 P
Just like in the lecture, you get all the materials to make the lemonade for free so
we assume that the costs of production are zero. Your goal, your objective, is to
maximize profits which is the same as maximizing total revenue given the zero
cost assumption.
1. a) (5 points) What is the profit (revenue) maximizing price and quantity (in
cups) of lemonade and the corresponding maximum profit.
Suppose that there was a demand shock so that the new estimated demand function
for lemonade in your neighborhood changes to:
Q = 100 – 100 P
1. b) (5 points) Name and support two reasons why demand would change like
this.
1. c) (5 points) Solve for the new profit (revenue) maximizing price and
quantity (in cups) of lemonade and the corresponding profit.
1. d) (5 points) Compare your quantity sold and your profit in part c) to the
quantity sold and profit if you kept ‘sticky’ lemonade prices – that is, what
would be the quantity sold and profit if you did not change prices?
GRAPHICS (30 points total for a correct and completely labeled diagram)
Just like in the lecture on the lemonade stand, draw a demand curve in your top
diagram and a total revenue function below making sure that you exploit the fact
that the horizontal axis is the same in the top and bottom diagrams. Label the
initial equilibrium points according to your answer in part a) as points A. Then,
label on both diagram as points B, the answer you gave in part c). We can think of
this as the long run since you will increase price in the long run. Then, label as
point C, the quantity sold and profit if you did not change price (i.e., your work
from part d).
1. e) (5 points) On a separate diagram, draw a supply curve that pertains to
your behavior from points A to B and another supply curve that pertains to
points A and C. Pretending that these are short-run aggregate supply curves,
under which curve would macroeconomic (demand side) policies have the
most effect on output? On prices? In other words, which supply curve is
more Keynesian and which is more Classical?
1. f) (5 points) Suppose that in order to change prices, you need to make a new
sign which costs you $5, these are referred to as menu costs. Is it worth it for
you to change prices, why or why not? Explain.
Part 2: True/ False Questions (2 points each – 40 points total) Answer T for True
and F for False




A fall in the tax rate on capital will cause the aggregate expenditure curve to
shift up and the aggregate demand curve to shift to the left, all else constant.
One reason that the aggregate demand curve slopes downward is that when
prices rise, say in the US, the relative price of imports fall and thus, US
citizens substitute away from domestically produced goods toward imported
goods and thus, GDP in the US will fall (all else constant).
Suppose the value of the US dollar changes from $1 = 1.2 euros to $1 = 1.30
euros. This being the case, imports from the US to Europe, have become
more expensive to European citizens, all else constant.
One reason the aggregate demand curve slopes downward is due to the fact
that if the price level falls, real money balances rise, all else constant,
interest rates will fall causing an increase in consumption and investment.
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Assuming that natural gas for firm X is an important input to the production
process, an increase in the availability of natural gas that lowers the price of
natural gas, will result in a leftward shift of firm X’s supply curve.
According to the lecture on the cyclical properties of the aggregate supply
curve, I argued that aggregate demand side policy works better, in terms of
influencing output, when the economy is operating at near full employment
output relative to when the economy is operating at levels of output well
below full employment.
If labor markets become “loose” and wages fall, all else constant, the short
run aggregate supply curve will shift to the left.
The more ‘sticky’ nominal wages and other input costs are, the steeper the
slope of the aggregate supply curve and therefore, the less effective demand
side policies in terms of effecting real output.
If the US economy is growing faster that the rest of the world, then we
would expect a surge in US exports.
Suppose that expected inflation is 5% and thus, nominal wages rise, along
with all other input prices by 5%. Suppose also, that actual inflation over
this period was only 2%. In terms of the behavior of the short-run aggregate
supply curve, it would shift up given the expectations of higher inflation and
then shift downward to adjust for the actual rate of inflation.
The more sensitive consumption is to real wealth, the steeper the aggregate
demand curve.
During the Great Recession, we argued that the aggregate expenditure curve
shifted downward and the short-run aggregate supply curve and the
aggregate demand both shifted to the left.
Anything that shifts the investment demand curve to the right will also shift
the aggregate demand curve to the right.
The Obama administration in 2013 let a tax holiday expire which effectively
increases income taxes for all workers who pay into social security. The
effect of this increase in taxes, all else constant, would shift the consumption
function down, the aggregate expenditure curve down, and the short-run
aggregate supply curve to the left.
Given that the working age population is shrinking in Japan, our discussion
about the determinants of the potential growth rate of the economy suggests
that this demographic reality would lower the potential growth rate of the
economy for Japan, all else constant.
One reason the short-run aggregate supply curve slopes upward is due to the
‘stickiness’ of input prices relative to output prices. We saw this in the
plastering example when we let output prices rise and kept nominal wages
constant. This being the case, the firm’s profit maximizing output rises with
the rise in prices, all else constant.
According to our discussion about the cyclicality of the aggregate supply
curve, the closer the economy is to potential output, the more Keynesian the
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world and thus, the more effective aggregate demand side policies are in
terms of effecting real GDP.
If output prices rise without the nominal wage rising, then real wages rise
and workers are willing to work more. This is one of the main reasons that
the short-run aggregate supply curve slopes upward.
When we discussed the stagflation of the 1970s, we argued that
policymakers should have acted more aggressively with expansionary
policies the fight the recession that occurred during that time.
The more flexible wages and prices, the steeper the short-run aggregate
supply curve. In fact, if prices and wages (and other inputs costs) are
perfectly flexible then we are in a ‘classical’ world, where the short-run
aggregate supply curve is vertical.
ECON 104 HOMEWORK #8 (100 points total)
Part 1: (60 points total)
Money Supply Problem
You are hired by the Chair of the Federal Reserve to manage the trading desk at
the New York Fed and the Chair tells you that he wants you to increase the money
supply (M1) by 33 percent. He/she warns you to be careful because in these
uncertain times, the money multiplier tends to become very unstable. He/she
suggests that you stay ‘closely connected’ with the banking sector and he gives you
a list of phone numbers to do so. Note that in this problem we are targeting the
growth rate of M1.
Reserve Market
Initial Conditions
rr/D= .10
C = 400 b
D = 2000 b
ER = 00 (not a typo)
M=C+D
1. a) (6 points) Show your work!
1. Calculate the MB.
1. Calculate the money multiplier.
iii.
What is the money supply (use mm x MB to calculate this)?
So you decide to inject $100 billion in reserves via open market purchases with
phone in hand. Recall, the Chair said to watch that multiplier and so you start
making some calls. Just as you suspected, the banks aren’t making any loans, that
is, they are sitting on all $100 billion in excess reserves.
1. b) (6 points) Given these new conditions, redo part a).
1. c) (6 points) Now the Chair calls and asks you how things are going and you
tell him/her that you injected $100 billion in the system but it didn’t work.
In the space below, write down what you would say to the chair (i.e.,
explain why the injection did not work).
Now you get some calls from bankers and you learn that there has been some
‘internal substitution’ within the M1 money supply. In particular, households
prefer to hold more currency relative to deposits, i.e., the currency to deposit ratio
rises. The numbers are as follows:
rr/D= .10
C = 800 b
D = 1600 b
ER =100 b
1. d) (6 points) redo part a)
1. e) (6 points) Now the Chair is not pleased with your work, and calls again.
Assuming that the money multiplier is now stable (i.e., the value in part d),
what must you do, in terms of open market operations, to hit the 33
percent money growth rate desired by the chair and the FOMC? Please
show all work!
2010. f) (10 points) Calculate the total percent change in the monetary
base, the money multiplier, and the money supply (from part a) to part e))
and compare to the actual real world percent changes since this crisis
began in August of 2007 to the end of 2010. Please use the following links
and click “view data” on the upper left to obtain the actual real world
values. For the monetary base start in August 2007 (this is monthly data),
for the money multiplier start 8/15/07 (bi-weekly data) and for M1 start at
8/13/2007 (also weekly data)).
1. g) (20 points) Graphing exercise: In the space below, draw two diagrams
with a graph of the Monetary Base on the left and the Money Supply on the
right. Locate as point A, the conditions that prevailed in part a), locate as
point B, the conditions that prevailed in part b), locate as point C, the
conditions that prevailed in part d) and finally, locate as point D, the
conditions that prevailed in part e). Helpful hints: don’t worry about
labeling interest rates, the variable on the vertical axis, since there are none
in this problem. Simply draw vertical lines (as we did in the lecture)
labeling the value of the MB and MS on the horizontal axis with the
appropriate points (A, B, C, D). If the curve doesn’t change (hint, this
happens with MS but not MB), simply label it with the appropriate A = B or
whichever applies.
Part 1: (60 points total)
Part 2: True/ False 40 points total (2 points each)
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If the excess to reserve deposit ratio goes up along with the currency to
deposit ratio, all else constant, then we are unsure what happens to the
money multiplier since the money multiplier is negatively related to the
excess reserve to deposit ratio but positively related to the currency to
deposit ratio.
During each FOMC meeting policymakers discuss the current state of
economic affairs in each of the 12 regional districts that make up the US. In
fact, the Presidents of all the regional Federal Reserve Banks attend all
FOMC meetings and discuss the conditions in their respective districts.
If the Fed was worried about overheating (GDP growing too fast,
inflationary pressures building), then the appropriate open market
operation would be for the Fed to conduct open market sales.
The FOMC meets in Washington DC but the action, in terms of conducting
open market operations takes place at the New York Fed (FRBNY).
During the Great Depression, the excess reserve to deposit ratio rose for a
variety of reasons. The impact on the money multiplier was negative. That
is, all else constant, a higher excess reserve to deposit ratio lowers the
money multiplier.
In the lectures, we argued that the money (M1) multiplier (since October
2008) has been rising given that banks have been ‘hoarding’ money (due in
part to the fact that the Fed is paying interest on excess reserves) resulting
in a rise in their respective reserve to deposit ratios.
If the money multiplier is 3 and the Fed conducts $100 billion of open
market sales, then the money supply will increase by $300 billion.
If the money multiplier falls by 50%, then the Fed, to keep the money
supply constant, would have to double the monetary base.
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Prior to October 2008, the M1 money multiplier was trending downward
since the required reserve ratio administered by the Fed was trending
upward.
According to the quantity theory of money in percent change form, then if
velocity falls so that its growth rate is negative then the Fed, to keep
inflation and output growth stable, should match the decrease in velocity
with an equivalent increase in the percent growth of the money stock.
According to Milton Friedman, inflation is always and everywhere, caused
by excessive economic growth.
The reason that the existence of money increases efficiency in the economy
is that it allows society avoid the double coincidence of wants and
therefore, allows people to specialize in what they do best.
Assuming that the nominal return on money is equal to zero, the real
return to holding money is the inflation rate.
The largest component of household sector wealth is wealth in the stock
market.
M2 is more liquid than M1 since M2 includes traveler’s checks where M1
does not.
The FOMC meets every month unless conditions warrant more frequent
meetings.
The Philadelphia Federal Reserve Bank is responsible for monitoring
economic activity in their district which includes the economic activity in
State College, PA.
According to the lecture discussing the October 2012 FOMC statement, the
Fed plans on buying $85 billion per month in longer term securities in
hopes of lowering long term interest rates.
According to the lecture discussing the October 2012 FOMC statement,
they plan on keeping their target for the federal funds rate in the range of 0
– .25% at least through mid 2015.
All regional bank presidents of the Federal Reserve system vote at all FOMC
meetings.
Open market operations influence reserve supply. For example an open market sale
will increase reserve supply.
According to our discussion on the FOMC statement from August 2007, the Fed
was worried about inflation getting too high
Following the 2001 recession (aka the job-loss recovery), the Federal Reserve
lowered their target for the federal funds rate all the way down to 1%
Following the job-loss recovery, the FOMC raised the target for the federal funds
rate 17 meetings in a row
Since December 2007, the federal funds rate has been at the zero bound with the
official target being a range from zero to .25%
During the lead up to Y2K, reserve demand was decreasing since banks were
afraid to make loans
During the lead up to Y2K, the Fed, to keep the federal funds rate from rising, had
to conduct open market purchases. This action is referred to as ‘accommodating’
the shock to reserve demand.
During normal times before the zero bound, the Fed forecasts reserve demand and
supplies the necessary reserves to meet their federal funds target. The better the
forecast the closer the actual federal funds rate is to the target federal funds rate
In order to raise the federal funds rate the Fed would conduct open market sales
When discussing money demand we argued that people tend to hold more money
as the interest rate rises all else constant
If the Fed conducts open market sales then the price of bonds should fall
According to our money demand/ money supply analysis an increase in GDP = Y
all else constant, will result in a rise in nominal interest rates
According to the percent change form of the quantity theory of money, if velocity
falls by 10%, then the Fed, inorder to achieve their dual mandate should let the
nominal money supply grow by 15%
A portfolio shock such that the households will want to hold less money at any
given interest rate will result in the velocity of money falling
Milton Friedman felt that high inflation was always caused by excessive money
growth. In fact he has been quoted as “inflation is always and everywhere a
monetary phenomenon”
ECON 104 HOMEWORK #9 (100 points total)
Part 1: 70 points total
1) (25 points total) We are going back to the fall of 1998, back in the ‘midst’ of
the new economy.
The Us economy weathered the E. Asian quite well and the US economy , by
almost all accounts,
was performing brilliantly. In August of 1998, Russian defaulted on all the
debt held by foreign
investors. This “shock” rattled financial markets so much that the Fed went
into action and
lowered short term interest rates 3 times in a seven week period. In what
follows, we are going to
model this 7 weeks period using our new acquired reserve demand / reserve
supply diagram.
In order to do this problem correctly, we need to go back to 1998 and ‘fetch’
the three relevant
FOMC statements. To help you along, I provide the links for you below.
Statements (1998) September 29 October 15 November 17
Note importantly, we are modeling the behavior of the federal funds rate
during this period. The
forecasted reserve demand at this time is given below. For simplicity, this
reserve demand
function is stable (constant) throughout this exercise.
Rd = 900 – 100 iff
a) (10 points for correct and completely labeled diagram) In the space below,
draw a
reserve demand / reserve supply diagram depicting as point A, the conditions
before the
FOMC meeting in September, 1998. Note, you need to use the prevailing
federal funds
target and solve for the appropriate reserve supply. You will be adding points
B, C, and D
to this diagram.
b) (5 points) Now show as point B, the conditions shortly after the FOMC
meeting on
September 29, 1998. Please show work.
c) (5 points) Explain exactly how the Fed (the FOMC in Washington DC)
changes
conditions in the federal funds market. Be sure to refer this particular case,
the movement
from point A to point B.
Now add to your diagram as point C, the conditions in the federal funds
market shortly
after the statement in October and point D, the conditions in the federal funds
market
following the FOMC meeting in November (the points for this part are
included in the
points for the complete and correctly labeled diagram.
d) (5 points) Now label points B, C, and on the diagram below.
2) (45 points total) In this problem, we are going to use the money market to
model two real world
events:
i) a portfolio shock to money demand and ii) a shock to the money multiplier.
Suppose you have the following information:
Original money demand function:
Md = P X [ 200 + .5 Y – 200 i]
where P = 1 (P remains constant in this problem), Y = 1600, M s = 600, MB =
400 MM=1.5
a) (5 points) Solve for the nominal interest rate ( i ) that clears the money
market.
b) (10 points for correct and completely labeled diagram) In the space below,
draw a money
demand / money supply diagram depicting these initial conditions.
c) (5 points) We now experience a portfolio shock to money demand so that
the new money
demand function is:
Md = P X [ 400 + .5 Y – 200 i]
Solve for the new market clearing interest rate, assuming there is no change in
the
money supply and label as point B on your diagram.
d) (5 points) Assuming the Fed wanted to keep interest rates constant, what
would they
need to do exactly? Please explain and show as point C, the conditions after
the Fed did
what they need to do to keep interest rates steady and their initial level as in
part a).
(10 points for a correct and completely labeled diagram) Re-draw a money
demand and
money supply diagram showing the initial conditions and label as point A.
e) (5 points) Instead of a portfolio shock to money demand, we now experience
a shock to
the money multiplier. In particular, the money multiplier (MM) falls and is
now = .8 (it was
1.5 before the shock). Assuming the Fed does nothing, what is the new money
market
clearing interest rate? Label this as point B on your diagram.
f) (5 points) Now we assume that the Fed is pro-active and responds to the
money
multiplier shock immediately to keep interest rates at their initial level. What
would the
Fed have to do exactly in terms of open market operations (show work) and
label this as
point C on your diagram.
Part 2: True/False (30 points total – 2 points each)
1) Open market operations influence reserve supply. For example, an open
market sale will
increase reserve supply.
2) According to our discussion on the FOMC statement from August 2007, the
Fed was worried
about inflation getting too high.
3) Following the 2001 recession (aka, the job-loss recovery), the Federal
Reserve lowered their
target for the federal funds rate all the way down to 1%.
4) Following the job-loss recovery, the FOMC raised the target for the federal
funds rate 17
meetings in a row.
5) Since December 2007, the federal funds rate has been at the zero bound
with the official target
being a range from zero to .25%.
6) During the lead up to Y2K, reserve demand was decreasing since banks
were afraid to make
loans.
7) During the lead up to Y2K, the Fed, to keep the federal funds rate from
rising, had to conduct
open market purchases. This action is referred to as ‘accommodating’ the
shock to reserve
demand.
8) During normal times, before the zero bound, the Fed forecasts reserve
demand and supples the
necessary reserves to meet their federal funds target. The better the forecast,
the closer the
actual federal funds rate is to the target federal funds rate.
9) In order to raise the federal funds rate the Fed would conduct open market
sales.
10) When discussing money demand, we argued that people tend to hold more
money as the interest
rate rises, all else constant.
11) If the Fed conducts open market sales then the price of bonds should fall.
12) According to our money demand / money supply analysis, an increase in
GDP = Y, all else
constant, will result in a rise in nominal interest rates.
13) According to the percent change form of the quantity theory of money, if
velocity falls by 10%,
then the Fed, in order to achieve their dual mandate, should let the nominal
money supply grow
by 15%.
14) A portfolio shock such that households want to hold less money, at any
given interest rate, will
result in the velocity of money falling.
15) Milton Friedman felt that high inflation was always caused by excessive
money growth. In fact,
he has been quoted as “Inflation is always and everywhere a monetary
phenonemon.”
ECON 104 HOMEWORK #10 (100 points total)
Part 1
1. (35 points total) We discussed the idea of crowding out and why it occurs. In
this
problem we are considering two scenarios: Scenario 1: G rises and the Fed does
not
accommodate the shock to money demand. Scenario 2: G rises and the Fed
accommodates the shock to money demand, as they would if they were committed
to
the zero bound.
a. (10 points for each correct and completely labeled diagram). Draw three
diagrams side by side. On the left, draw a consumption function, in the middle,
draw a money market diagram, and on the right, draw an investment demand
function. Locate the initial equilibrium as point A, labeling the relevant values
using subscript A as in the level of consumption at point A as CA, the level of
interest rates as iA, etc.
Scenario 1: G rises, no accommodation by the Fed, locate the new equilibrium
as point B on all three diagrams, being sure to label your diagrams completely.
Show and explain the crowding out that Barro discusses in the “Government
Spending is no Free Lunch” article. In particular, we are assuming total crowding
so that Y does not change, along with the assumption of a closed economy. Be
sure to explicitly identify the crowding out on the consumption function and
investment demand functions that you drew above.
Scenario 2: G rises, the fed completely accommodates the shock to money
demand so that interest rates remain unchanged (identical to the Romer
assumption). Show this development as point C on all three diagrams.
b. (5 points) In the Romer paper, the multipliers that they use assume that the Fed
will keep interest rates constant for the foreseeable future. Referring to your
diagrams, does this assumption increase/decrease/ or have no effect on the
estimated spending multiplier? Explain.
2. (25 points total) Consider the following model
i) C = 1500 + mpc (Y – tY)
ii) I = 800
iii) G = 500
iv) X – M = 500 – mpi (Y)
where:
t = the (flat) tax rate
mpc = the marginal propensity to consume
mpi = the marginal propensity to import
suppose mpc = .80, t = .25, mpi = .2
a. (5 points) solve for the equilibrium output
b. (5 points) Solve for the (government) spending multiplier.
c. (10 points) When we discussed the multiplier we discussed the impact effect.
For example, suppose that G increases by 100 to 600 and we assume, as we
often do, that firms match the increase in demand by increasing Y by 100. In
round two, this is an increase in income of 100 to consumers. Trace out exactly
where this 100 increase in income goes in the second round and compare to our
simpler treatment with a closed economy and lump sum taxes. Hint, there are
three leakages to address(again, please be very specific as to where the 100
increase income ‘goes’ in this second round).
d. (5 points) What would happen to the multiplier if the mpi rises to .25. Please
explain the intuition.
True/False (40 points total – 2 points each)
1) Unemployment benefits are an example of fiscal policy.
2) According to Ricardian Equivalence in a strict sense, the tax multiplier is zero.
3) When looking at the GDP data from quarter 3 of 2012, government purchases
accounted for a larger share of the economy than investment expenditures did.
4) According to one of the lectures featuring a pie chart on federal government
expenditures, transfer payments went from about 25% of total expenditures in the
1960s
to over 46% of total expenditures in 2010.
5) As of 2010, interest payments on the federal debt exceeded 10% of total
expenditures.
6) We argued that the tax revenue that the federal government collects is procyclical, that
is, when economic activity is growing so is tax revenue. An example of this is the
new
economy when tax revenue increased along with the economic growth.
7) If aggregate expenditures exceed aggregate income then inventories will rise
and firms
will eventually lay off workers.
8) We argued that cutting the corporate income tax will have supply side effects in
that
cutting the corporate income tax can potentially increase the pace of technological
change with the implication being the aggregate supply will shift to the right.
9) According to the Laffer curve, increases in tax rates always result in less tax
revenue.
10) One reason that tax revenue may fall when tax rates are increased is due to tax
evasion,
that is, the higher the tax rate, the higher the probability of the tax evasion and
thus,
lower tax revenue. The example I used was when Canada quadrupled the tax rate
on
cigarettes Canadian citizens sought out to buy illegally smuggled in US cigarettes
to
evade the tax on Canadian cigarettes.
11) The term ‘voodoo economics’ is a term used by the proponents of supply side
economics trying to explain to its critics that lower tax rates will result in higher
tax
revenue.
12) Barro is considered to be a supply side economist which is consistent with his
idea that
we should eliminate the corporate income tax.
13) According to the table depicting the effective tax rate on capital for 2007, the
only
country that has a higher effective tax rate on capital is Greece.
14) According to our discussion of supply side economics, there are positive
aggregate
demand side effects and positive supply side effects, similar to what happened
during
the new economy.
15) We argued that the tax multiplier is higher in absolute value than the
government
spending multiplier.
16) The more the Fed accommodates shocks to money demand, the larger the
(government) spending multiplier.
17) According to the Congressional Budget Office (CBO), the stimulus package
worked in
terms of creating jobs, lowering unemployment, and raising GDP.
18) Spending by local governments to stimulate or slow down their local
economies is an
example of fiscal policy.
19) When talking about tax multipliers using tax rates instead of the more simple
lump sum
taxes, we argued that the social security tax cut resulted in a higher tax multiplier.
20) When we add the marginal propensity to import to our model, the spending
multiplier
falls. In fact, the higher the marginal propensity to import, the smaller the spending
multiplier, all else constant.
ECON 104 HOMEWORK #11 (100 points total)
PART 1 :
1. In the late 1960s, Milton Friedman and Edmund Phelps argued that there was
not a
structural relationship between inflation and unemployment rates. In particular, the
trade
off could only exist in the short -run.
a) (10 points) The tradeoff between unemployment and inflation was much
discussed throughout the 1960s as there appeared to be a clear tradeoff
between unemployment and inflation. In fact, we traced out the Phillips curve
beginning in the early 1960s and continuing through the end of the decade. In
the space below, recreate the Phillips curve that we constructed in the lectures,
being sure to label diagram completely. At minimum, you should have
unemployment / inflation combinations for 1961, 1962, 1964, 1966, and 1969.
Connect the dots and we have the tradeoff between unemployment and inflation
during the 1960s, aka, the Phillips curve.
b) (10 points) Now explain why the Phillips curve that you constructed can only be
a
short-run phenomenon at best. In particular, explain exactly why, as we went
through the decade of the 1960s, we continuously move up and to the northwest
along the Phillips curve…. from relatively high rates of unemployment and low
inflation to relatively low rates of unemployment and high rates of inflation. In
your answer, make sure discuss the short run aspect of this curve and why, in
the long-run, the Phillips curve is vertical (hint: expected inflation, unexpected
inflation, actual real wages, and expected real wages should be a big part of your
explanation).
2. In this question, we are going dig deeper into the Taylor Rule and it variants
(modifications). You will need the following links to answer the following
questions.
Note, each link takes you to a page where right above the graph on left, there is a
“download data in graph” tab – click on it and that will give you access to the data
you
need.
NAIRU
GDP Growth
PGE
Inflation PCE core
Unemployment Rate
Inflation PCE
Effective Federal Funds Rate
As Taylor assumed, we assume the equilibrium real rate of interest, r* = 2% and
the
optimal inflation rate, the target inflation rate is also equal to 2%.
a) (10 points) Using the ‘standard’ Taylor rule with Inflation PCE (not the core),
and
using end of 2011 data (2011-10-01) what is the federal funds rate implied by the
‘standard’ Taylor Rule? According to the actual federal funds rate (use the
Effective Federal Funds Rate), is the Fed being hawkish or dovish? Explain.
b) (10 points) Repeat part a) using the modified version of the Taylor using the
unemployment gap instead of the GDP gap just like we did in the lectures. Also,
use the PCE core rate of inflation instead of overall inflation like you used above
the Fed arguably cares more about core inflation than overall inflation. According
to the actual federal funds rate (use the Effective Federal Funds Rate), is the Fed
being hawkish or dovish? Which “Taylor” rule explains Fed behavior better, the
original or the modified Taylor Rule? Explain.
c) (10 points) Let’s go back in time to the fourth quarter of 1965 (1965-10-01)
when
the “We are all Keynesians” was featured in Time magazine. We argued that this
was
heyday of Keynesian economics so we would expect to get dovish results. Using
the
original Taylor Rule that you used in part a) and the modified Taylor Rule that you
used in
part b), prove that the Fed was dovish according to both versions of the Taylor
Rule.
d) (10 points) We now go back to the Volcker period where he was known as
being
a hawk on inflation. Using the data from the second quarter of 1982 (1982-04-01),
prove that the Volcker Fed was hawkish according to both versions of the Taylor
Rule
True/ False (40 points total – 2 points each)
1) According to the “We are all Keynesians Now” article, the labor secretary at
that time
wanted the unemployment rate to fall down to 3%.
2) The misery index in 1980 exceeded 25.
3) The mid to late 1970s was the ‘heyday’ of Keynesian economics in the US
economy.
4) Keynes believed that it was the responsibility of the government to use its
powers to
increase production, incomes and jobs.
5) Consistent with his thought on spending heavily, Keynes was known as an
excellent
tipper.
6) The steeper the SRAS curve, the steeper the short-run Phillips curve.
7) If the long-run aggregate supply curve is vertical so is the long-run Phillips
curve.
8) Friedman and Phelps agreed that there is a trade-off between unemployment and
inflation, but only in the long run.
9) If actual inflation is lower than expected inflation, then the actual real wage is
higher than
the expected real wage. This being the case, firms will lay off workers.
10) According to the Taylor Rule described in the lectures, if the Fed is getting an
A+, then
the federal funds rate should be set at 5%
11) According to the Taylor principle, if actual inflation rises by 1% over target
inflation, then
the Fed should raise the federal funds rate by 2% to make sure that the real federal
funds rate rises which is referred to as “leaning against the wind.
12) If the actual federal funds rate is higher than the funds rates implied by the
Taylor rule,
then we say that the central bank is hawkish.
13) If actual inflation rises one percent above target and the central bank raises the
actual
funds rate by one percent then according to the Taylor rule, the central bank is
being
hawkish.
14) According to the Taylor rule, the Greenspan Fed was hawkish during the new
economy
years.
15) According to the Taylor rule, the Greenspan Fed was hawkish during the jobless
recovery as well as the job-loss recovery.
16) One way to explain the apparent tradeoff between inflation and unemployment
during
the 1960s, expected inflation was consistently higher than the actual inflation
implying
that firms would be willing to higher more workers given this difference between
expected and actual inflation. The result therefore would be higher inflation and
lower
unemployment, consistent with the facts during the 1960s.
17) We argued that the modified version of the Taylor rule during the jobless
recovery
following the 1990 – 1991 recession explained Greenspan and the Fed’s behavior
much
better than the original Taylor Rule.
18) According to the Phillips curve analysis, if expected inflation is equal to actual
inflation
then we are at NAIRU. However, if actual inflation is higher than expected, then
the
actual unemployment rate will be higher than that associated with NAIRU.
19) If firms and workers had perfect foresight as to inflation so that actual =
expected
inflation at all times, then the Phillips curve would be vertical and thus, there
would be no
trade between unemployment and inflation, even in the short run.
20) We argued that a federal funds rate target of 4% is consistent with the stance of
monetary policy being neutral as in neither tight nor loose.
ECON 104 HOMEWORK #12 (100 points total)
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(20 points) Explain, in five sentences or less, exactly why the trade deficit in
the US increased from 1995 to 2000. There are two specific reasons. Make
sure you explain clearly (the intuition) why each reason would add to our
trade deficit.
2) (40 points total)
2001. (10 points) Suppose that you received your college degree from Penn
State and nailed a great job over in Europe in the summer of 2001. Given
that your family remains in the US, you make sure that you visit the family
every November by traveling from Europe to the US. We are going to
compare the cost of this vacation, in terms of euros, during two different
periods: November 2002 and November 2012. We assume that the cost of
the trip, in terms of $ US, remains the same at $1,000 in both periods.
Using the link below and rounding down to two decimals, compare the
euro cost of the trip in November 2002 vs. the euro cost of the trip in
November 2012.
See the Louis Federal Reserve site for $ per euro exchange rate (to get actual
data click on “view data” on left hand side of page)
1. (30 points – 15 points for explanation and 15 points for correct and
completely labeled diagram) Using the same link above, we are now going
to use our supply/demand framework for US $ to model the movement in
the euro per $ exchange rate between December 2007 (the very beginning
of the Great Recession) and November 2008 (pretty much the height of the
global financial crisis).
Note that the data is in $ per euro so you need to convert it into euro per
dollar before proceeding. For example, $ 1.2 per euro is converted by 1/1.2
= .833 meaning that $1 = .83 euro (this is the vertical axis on your graph,
i.e., euro per $).
Rounding down again to two decimals, draw a supply and demand diagram
like we did numerous times in the lectures labeling the vertical axis as euro
per $ and the initial supply and demand curves labeled with 12/07, Label this
initial point as point A.
Now explain what happened to each curve and WHY between 12/07 and
11/08. Label this new point (11/08) as point B with your supply and demand
curves labeled accordingly
(Hint: the two obvious facts during this period is that the 1) US was in a
deep recession and 2) we were at the height of the (global) financial crisis
(in 11/08). Assume all else is constant.
True/ False (40 points total – 2 points each)

In a closed economy, savings = investment is the same as the closed
economy goods market equilibrium condition we know as Y = C + I + G.

If income exceeds absorption, then the economy is ‘consuming beyond its
means.’

In the open economy goods market equilibrium with two large countries,
the sum of the absorptions must equal the sum of the incomes produced
by the two countries.

Goods market equilibrium in an open economy requires that savings equals
investment plus the current account.
If savings exceeds investment then the country is running a trade deficit
where NX < 0.
If NX is positive then the country is consuming beyond their means and
must borrow from the rest of the world.



During the mid 2000s, the current account deficit in the US exceeded 10%
of GDP.

We argued that when the economic growth in the US is greater than the
(economic) growth rates of our trading partners, the trade deficit in the US
should get larger, all else constant.

A country that intervenes in the foreign exchange market to keep their
currency weak is consistent with the country being export oriented.\

We argued that when the US economy grew briskly during the new
economy, the supply of US dollars in exchange for other currencies rose
since along with economic growth, our appetite for imports grows as well.
This effect, all else constant, would weaken the value of the $.

We argued that the E. Asian and Russian crises would map to our foreign
exchange market analysis as a decrease in the supply of dollars resulting in
a stronger US dollar.

During the Reagan Administration, the current account became a major
economic issue. In particular, the US began running a large current account
surplus where US exports were much larger than US imports.

Export oriented countries prefer a weaker currency relative to a stronger
currency.

If there is pressure for the Chinese yuan to appreciate against the US dollar,
then China can ‘fight’ this appreciation by buying $ with their yuan.

We argued that one reason that interest rates are low on government
securities is due to China’s exchange rate regime.

Monetary policy is thought to be stronger in an open economy relative to a
closed economy since if the Fed, for example, wanted to prevent the
economy from overheating, they would raise interest rates. Along with the
normal closed economy impact on consumption and investment, we also
would have a stronger dollar which would lower net exports, adding to the
power of monetary policy.

One reason fiscal policy is thought to be stronger in an open economy
relative to a closed economy is due to the fact that in an open economy
setting, the change in the interest rate effects the exchange rate and thus,
adds power to fiscal policy through this exchange rate channel.

A rush to the safe haven of $ US during a financial crisis is depicted in the
supply / demand model in the $ US market as an increase in the demand to
exchange foreign currencies in for $. The end result should be $ US
appreciation, all else constant.

We argued that the $ US was appreciating in the early years of the Reagan
Administration due to the expansionary fiscal policy during this time.

When people refer to the twin deficits in the US they are most likely
referring to the new economy years since this was the time twin deficits
occurred in the US economy..
ECON 104 Final Exam
1. Fill in the table below. The current wage is $200 and the price of output (Q)
is $30. Each box is worth V2 of a point. Enter whole numbers only (no
commas, no decimals, no dollar signs) and if a value is negative, be sure to
enter the negative sign.
L Q MPL
00
1
2
3
4
5
6
MRP
Marginal Total
Profit
Profit
0
7
15
22
28
33
37
2.Use the table from question 1 to complete the next six questions. Enter the
correct values in the boxes below. Enter only whole numbers (no commas, no
decimals, no dollar signs). Each fill-in-the-blank below is worth 3 points
This profit maximizing firm will hire
_________ workers.
3.This profit maximizing firm will produce _________ units of output.
4. This firm’s maximum profit equals _____________
5. Now suppose that the wage falls to $170. You will need to recalculate the
values from the table, given this new wage, to answer the questions below.
This profit maximizing firm will now hire _________ workers.
6. This profit maximizing firm will now produce _______units of output.
7. This firm’s maximum profit now equals ____________
8. Use the following information to answer the next nine questions. Each fillin-the-blank is worth 3 points.
If your answer is in decimal form, enter it with 2 decimal places. For example, if
your answer is .4, enter it into the fill-in-the-blank as .40, or if your answer is 1.4,
enter it into the fill-in-the-blank as 1.40. If there are no decimals in your answer,
you will simply enter the number; so if your answer is 2, enter 2 with no decimals.
Do not use commas.
Suppose the economy is characterized as follows:
AE = С + I + G + (X-M)
С = 400 + .75(Y – T) – 30 (r)
I = 500 – 50(r)
G = 400
X- M = -25
T = 80
r=5
Price level P is fixed at 1 (P=1)
Use the information above to get expressions for the consumption function and the
AE equation.
The vertical intercept for the consumption function is ____________
9. The slope of the consumption function is ___________
10 . The vertical intercept of the AE equation is ___________
11.The slope of the AE equation is _________
12.Equilibrium output is equal to ___________
13.Equilibrium consumption is equal to _____________
14.Suppose the Consumption function changes to C=500 +.75(Y-T) – 30(r).
The new value of equilibrium output is __________
15 . The new value of equilibrium consumption is ___________
16.The Consumption function is still C=500 +.75(Y-T) – 30(r). The Keynesian
spending multiplier in this economy is___
17.Use the following information to answer the next four questions. Each
multiple choice question is worth 3 points.
mm = money multiplier = .8
MB = monetary base = 3000
Money Demand: Md = P X [ a0 + .5 (Y) – 200 (i) ]
where: a0 = 1000. Y = 3600
For simplicity we hold the price level fixed at 1 and assume that inflationary
expectations are fixed at 2%. Y is also held constant in this problem.
What is the equilibrium interest rate (i)?
1. A) 1%
2. B) 2%
С) 2.5%
1. D) 3%
2. E) None of the above are correct
18.Suppose ao falls to 800. What is the new equilibrium interest rate?
1. A) 1%
2. B) 2%
С) 2.5%
1. D) 3%
2. E) None of the above are correct
19.Suppose that the Fed wanted to keep interest rates constant at their initial level
(the value you found in #1). What would the Fed have to do in terms of open
market operations to achieve this?
1. A) 200 in open market sales U
В) 200 in open market purchases
С) 250 in open market sales
1. D) 250 in open market purchases
2. E) 2200 in open market sales
3. Given the interest rate you found in #18. what is the ex-ante real interest
rate?
A)-1%
1. B) 0%
С) 1%
1. D) 2%
2. E) None of the above are correct