Download Macro3 Exercise #4 Answers

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Macro3 Exercise #4 Answers (
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Please limit your answers to the spaces provided. If necessary, write on the back of the page.
Do not attach printout or additional pages. All questions pertain to the Macro3 module in the
SimEcon® software package.
Make sure that you have read the “Macro3 Manual” and “SimEcon® Operation
Instructions.” These materials may be found at the Class Web site prior to beginning the
exercise. For many of the exercise’s questions, it will be necessary to refer to those instructions.
For many of the exercise’s questions, it will be necessary to refer to your text.
Open the Macro3 module. You will see a table entitled, “State of the Macroeconomy.” Select
the button entitled, “Recession” and click “Continue.” You will see the “Initial State of the
Economy.” What is the current level of output (real GDP)? $2,330.36. What is the current
unemployment rate? 7%. Is this indicative of a recession? Yes (Yes, No). According to
most economists, when the unemployment rate is above what percent, the economy is considered
to be in a recession? 5%. When unemployment occurs, what is lost forever? The output that
those workers who are unemployed could have produced if they had been working is lost
forever.
What is the rate of inflation that is indicated by this table? - 11.57%. What is the price level?
0.884. Is the current inflation rate and price level typical for a recession in the United States
and other rich nations? No (Yes, No). What is different about it? Deflation (prices falling)
in slight recessions is unusual though not unheard of, such a high rate of deflation is
unheard of. How does inflation affect borrowers (assuming that the loan is not indexed and has
a fixed interest rate)? Borrowers can pay back their loans with money that is worth less in
real terms than the original amount that they borrowed. Is this situation good for borrowers
if the inflation was unexpected? Yes (Yes, No). How does unexpected inflation affect lenders
(assuming that the loan is not indexed? Lenders receive payment from the borrowers in
money that is now worth less in real terms that the original amount loaned. Is this situation
good for lenders? No (Yes, No). How does inflation affect people on fixed incomes such as
AFDC (assuming that the payment is not indexed and that there are no cost of living increases)?
People on fixed incomes receive money that is worth less and less in real terms as the
inflation proceeds. How does unexpected deflation differ in its effects from inflation? All the
above results are reversed.
Click “Continue.” Enter the following amounts: government spending (G) = $970, taxes (T) =
$850 and the money supply (MS) = $71. Is the government running a balanced budget, a budget
deficit or a budget surplus? The government is running a budget deficit. If the goal of the
government is to reduce unemployment, are these changes working in tandem with each other or
working against each other? These policies are working together. Click “No Shock.” What
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Macro3 Exercise #4 Answers
is the new level of output (Real GDP)?
short run output? Yes (Yes, No).
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$2,360.40. Has this policy succeeded in increasing
What is the new unemployment rate? 4.00%. Has this policy succeeded in reducing
unemployment? Yes (Yes, No). What is the new inflation rate? 7.46%. Does this new
inflation rate represent a short run cost or disadvantage of the above policies? Yes (Yes, No).
Click “New Policy.” Suppose that groups hurt by inflation forced the government to try to cut
inflation. Enter the following: G = $900 T = $900 and MS = $66. Is the government running a
balanced budget, a budget deficit or a budget surplus? The government is running a balanced
budget. Does it make sense to reduce the money supply in order to reduce inflation? Yes.
Click “No Shock.” What is the new level of output (Real GDP)? $2,348.09. Has this policy
succeeded in increasing short run output? No (Yes, No). What is the new unemployment rate?
5.23%. Has this policy succeeded in reducing unemployment? No (Yes, No). What is the new
inflation rate? – 1.25%. When the inflation rate is negative, what is happening to prices? In
that case, prices are going down. What is the term used to describe this situation of negative
inflation? Deflation. Compared to the last paragraph, has this policy succeeded in maintaining
relative price stability? Yes (Yes, No). What are the costs of this policy? Short run real
output is decreased and unemployment is increased. Click “See Graph” and draw the
resulting graph that you see below. Label all axes and indicate the old and new aggregate
demand and aggregate supply lines. Indicate the full employment level of output.
P
AS
AS´
AD
AD´
GDP
GDPFE
Consider the previous equilibrium point. Is it below, at or above the full employment level of
output? The previous equilibrium point is above the full employment level of output. Is it
possible for an economy to be above full employment? Yes (Yes, No). If the economy is above
full employment, does that mean that adolescents, retired people, and others who really don’t
want to work long term are nevertheless drawn into the labor force? Yes (Yes, No). If the
economy is above full employment, does that mean that some people might be working overtime
when they don’t want to do so indefinitely? Yes (Yes, No). Why would these things happen?
One reason is that some workers have been fooled by the inflation -- they are offered
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Macro3 Exercise #4 Answers
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higher (nominal) pay, think that means higher real pay (since some of the inflation was
unexpected) and therefore supply more labor. When they find out in the long run that they
have been tricked they cease offering the additional labor.
Consider the new equilibrium point. Is it below, at or above the full employment level of
output? The new equilibrium point is below the full employment level of output. Is this
consistent with the indicated unemployment rate (Refer to the last rate generated.)? Yes (Yes,
No).
Click the “Back” button. This will return you to the previous table. At this point, click “No
Shock-Long Run.” What is the reported real GDP in the long run? $2,350.03. Is this output
significantly different from the full employment level of output? No (Yes, No). What is the
reported unemployment rate in the long run?
5.00%. Would a significant number of
economists consider this to be “acceptable”? Yes (Yes, No). What is the reported inflation rate
in the long run? 0.03%. Does this seem to be an “acceptable” level of inflation? Yes (Yes,
No). Does this data indicate that this economy always gravitates toward full employment
equilibrium in the long run in the absence of any shocks? Yes (Yes, No). In terms of the
Aggregate Supply and Demand model why does the economy move like this in this long run? It
is a result of shifting aggregate supply. In the underlying economy why would this happen?
Due to the high unemployment rate (compared to full employment) wages fall by more
than prices so production becomes more profitable at a given price level. That is why the
supply line shifts.
Is there any real consensus among economists as to how long the “long run” really is? No (Yes,
No). Could the long run be as long as two or three years? Yes (Yes, No). If that is the case,
how do unemployed people survive in the meantime? They survive by receiving government
assistance such as unemployment compensation or welfare, or through private charity, or
using up their stock of previous savings, selling their belongings, etc..
Click “New Policy.” Suppose that in the short run, the workers were angry at the high
unemployment rate and demanded that something be done about it. In that case, if the only goal
of the government was to reduce unemployment, government spending should be increased
(increased, decreased, left unchanged), taxes should be decreased (increased, decreased, left
unchanged) and the money supply should be increased (increased, decreased, left unchanged.
Enter the following amounts: G = $890, T = $910 and MS = $65. In light of the immediately
preceding answers, does this seem like a wise policy? No (Yes, No). Click “No Shock.” What
is the new inflation rate? – 2.91%. What is the new unemployment rate? 5.49%. Would the
workers be happy with this situation? No (Yes, No).
Now click “New Policy” again. Enter the following amounts: G = $1000, T = $850 and MS =
$65 Click “No Shock.” What is the new unemployment rate? 5.15%. Would the workers be
relatively happy with this situation? Yes (Yes, No). What is the new inflation rate? -0.73%
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Macro3 Exercise #4 Answers
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Suppose that the workers pressed for even more reductions in the unemployment rate. Click
“New Policy” and enter the following amounts: G = 1050 (Warning: do not use a comma when
entering this, it may be read as a decimal point.), T = 825 and MS = 72. Click “No Shock.”
What is the new unemployment rate? 3.62%. What is the new inflation rate? 10.43%. What is
the reduction in the unemployment rate from the last example? Unemployment was reduced
by 1.53%. What is the increase in inflation (decrease in deflation) from the last example?
Inflation increased by 11.16%. Did society enjoy a large decrease in unemployment compared
to the related increased in inflation? No (Yes, No).
Suppose that the costs to society of another 1% inflation or deflation and the cost of another 1%
unemployment were about the same. Which of the above policies gave this society the lowest
combined costs in the short run? The costs would be (using the absolute value of the inflation
rate because the costs of deflation and inflation are assumed to be the same):
1)
2)
3)
4)
5)
6)
Inflation
-11.57
7.46
-1.25
-2.91
-0.73
10.43
unemployment
7.00
4.00
5.23
5.49
5.15
3.62
total costs
18.57
11.46
6.48
8.40
5.88
14.05
Which policy gave this society the lowest overall costs? Policy 5. Did this policy give a short
run result close to the long run equilibrium? Yes (Yes, No) If the government’s goal for setting
policy was to minimize total costs of inflation and unemployment which policy of these six
should be chosen? Policy 5 If this was the government’s only goal would it matter in the long
run which policy it selected? No (Yes, No) Explain why or why not. In the long run none of
these differences in policy change the inflation or unemployment rates, so the long run had
the same costs of both regardless of these short run policy choices. Do economists use this
measure of social costs to measure the desirability of policies? Yes (Yes, No) What is the
“misery index?” The misery index is the total cost measured as in the table above.
Would everyone agree that the costs of inflation (per 1%) and of unemployment (per 1%) are the
same? No (Yes, No) Why or why not? Different groups experience different costs from each
of these sources and those who experience more of the burden of inflation and less of the
costs of unemployment are likely to consider that inflation is more costly to society. The
opposite is true for groups that bear more of the burden of unemployment relative to
inflation. This would cause disagreement even if there were proof that “overall” social
costs were the same.