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Click Link below To Purchase: http://www.madehomework.com/product-category/econ-104/ 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. 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. 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 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. 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. 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 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) 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. 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) (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