Download EC 132 Discussion Note PS2 CHIU P.1 Disclaimer:

EC 132 Discussion Note PS2 CHIU P.1 Disclaimer: All questions are adapted directly from the textbook and problem sets. Suggestions from Professor Tresch are used in preparation of this note. All solutions are just suggestive and tentative comments, not marking criteria actually adopted, subject to further changes and interpretations. Question 1 (Q7 in Chapter 7, p.176)
Discuss the following statement, making use of the Fisher equation where appropriate:
Unanticipated inflation causes a redistribution from lenders to borrowers, where a fully
anticipated inflation does not.
Definition: (Fisher equation) The relationship between observed, or nominal interest
rates and the underlying real interest rates that says that the observed interest rate
on a financial security equals the real interest rate plus the expected rate of
inflation.(P.166)
Lender would take expected inflation into accounting when setting the interest rate. Hence,
unanticipated inflation reduces purchasing power of the load but fully anticipated inflation does
not.
Question 2 (Q9 in Chapter 7, p.176)
a) What does it mean to say that the dollar has depreciated in value?
Definition: (Appreciation) The value of a nation’s currency rises relative to the value
of other currencies. (P.196)
Hence, dollar appreciates means $1 can get more €, £ or ¥ then before.
b) Who gains and who loses in the United States from a depreciation of the dollar?
Gain: US exporter, US import competing industries
Loss: US consumer
c) Who gains and who loses in Germany form a depreciation of the dollar against the
Euro?
Gain: German consumer
Bad: German exporter, German import competing industries
Question 3 (Q10 in Chapter 7, p.176)
a) Why must the value of imports equal the value of exports for most countries?
No one can have free lunch. One must pay in order to get. Because a country has to pay for
imports in her own currency, (i) foreign exporters spend the money (home export increase), (ii)
switch back to exporter’s currency (currency value would adjust accordingly, then export would
be boosted so that eventually trade would be in balance.) or (iii) save the money (bonds or
investment).
Definition: (Balance of Trade) The difference between the value of a nation’s exports
and the value of its imports (merchandise exports and imports only, exclude trade in
services) (P.168)
b) Why do large industrial countries like the United States not have to maintain an equal
value of imports and exports every year? Why, though, must the value of the imports and
their exports be approximately equal over time?
People have confidence in the currency so cyclical unbalance of trade would not seriously swing
the currency value.
EC 132 Discussion Note PS2 CHIU P.2 However, if the unbalance is too structural, then either currency depreciates or balances by
itself. As we have explained in (a), no one can consume by having others saving forever.
Question 4 (Q5 in Chapter 8, p.203)
a) What is the difference between disposable income and national income?
Definition: (National Income) The value of the labor, capital and land exchanged in
the nation’s factor markets during the year. (P.178)
Definition: (Disposable Income) The income available to households for their own
use, to be consumed or saved. (P.190)
The main differences are (1) taxes and the transfers of the federal, state and local government,
and (2) retained earning of business firms.
b) Why is each of these income concepts important to the study of macroeconomics?
National Income: How economy performs?
Disposable Income: How much household really gets?
Question 5 (Q9 in Chapter 8, p.203)
Suppose that a country had a real GDP per person of $10,000 in 1950 and now has a real
GDP per person of $15,000. Can we conclude that the citizens of the country are better
off now than they were in 1950?
There are several reasons why real GDP per person is not a perfect measure for living
standard: (1) non-market activity (2) underground economy (3) quality changes (4) pollution,
and depleted resources, (5) leisure and (6) distribution (Remember: Ginni coefficient?).
(Refer to P.198 in textbook for further details.)
Question 6 (Q10 in Chapter 8, p.204)
The data in the table below refer to the same simple economy described in the chapter.
Wheat is used to make flour, flour is used to make bread, and bread is sold to consumers
as a final product. Labor is the only primary factor of production. Fill in the missing
entries in the table.
Intermediate
labor
sales
value added
materials
Wheat
0
Flour
10
20
Bread
50
Also calculate the national income, total value added, total sales in the economy, and
consumption of bread.
Intermediate
labor
sales
value added
materials
Wheat
0
10
10
10
Flour
10
20
30
20
Bread
30
50
80
50
Total
40
80
120
80
Consumption
80
National income = Total value added = Consumption = 80.
Total sales = 120 (Note: total sales of final good = 80, consistent with circular flow model)
EC 132 Discussion Note PS2 CHIU P.3 Discussion Question
What do you consider to be the most pressing of the four macroeconomic policy
problem today? Do you believe other current economic problems are as important or
more important than any of the four macroeconomic policy problems? Answer these
questions with respect to the US economy.
1. Unemployment
2. Long run growth
3. Inflation/deflation
4. Housing price
5. Trade deficit/weakening of dollar
6. Budget deficit (debt is about 1 year GDP)
7. Income inequality (since 2000)
8. Health care financing (baby boomer aging)
9. Financial regulation
10. Energy issue