Download Macroeconomic Theory M. Finkler Suggested Answers to Spring

Macroeconomic Theory
M. Finkler
Suggested Answers to Spring 2007 Midterm Exam #1
1.
W/P = d0 – d1*L + d2*K + d3*RM (1)
Endogenous
Ls = so + s1*(W/P)-s2*T
(2)
Variables
L = Ls
(3)
W, P, L, Ls, Y,
Y = 100*L^.75*K^.25
(4)
AD, C, I
AD = k*M/P
(5)
AD = C + I + G
(6)
C = .75*Y
(7)
Y = AD
(8)
a.
To determine W/P plug (3) into (2) and then (2) into (1)
W/P = d0 – d1*(so +s1*(W/P)-s2*T) + d2*K + d3*RM
Exogenous
Variables
T, K, RM, G
Distribute d1 across the terms and move the term with W/P to the left hand side.
W/P + d1* s1*(W/P) = d0 –d1*s0 +d1*s2*T + d2*K + d3*RM
thus, (A) W/P = d0 –d1*s0 +d1*s2*T + d2*K + d3*RM
- equilibrium real wage
1 + d1*s1
The easiest way to determine L is to plug (3) into (2) and then (1) into (2) and solve for L
(B)
L = s0 + s1*d0 + s1*d2*K + s1*d3*RM -s2*T – equilibrium labor
1 + d1*s1
b.
To obtain the AS curve, plug the equilibrium quantity of labor into (4)
Y = 100*( s0 + s1*d0 +s1* d2*K + s1*d3*RM -s2*T).75*K.25
1 + d1*s1
This is the aggregate supply curve. It contains no price term and, thus, is vertical.
c.
Since there are no endogenous variables on the right side of C, that equation is
also the reduced form equation for Y.
(C)
d.
An increase in taxes would shift the labor supply curve toward the real wage axis,
so real wages would rise and employment would fall. In equation A, the coefficient on
taxes is positive, hence increases in taxes yield increases in W/P. In equation B, the
negative sign on T means that an increase in T leads to a fall in L. The same result holds
for equation C, so both Y and L would fall. Using equations 5 and 8, Y = k*M/P; since Y
decreases (from C) and k and M are unchanged, P must rise. This result is consistent
with a leftward shift in the AS curve.
e.
A decrease in (oil) raw materials decreases the demand for labor and thus the real
wage and employment. The coefficients on RM in equations B and C are positive; thus,
employment and output wound fall. Using equations 5 and 8, as in part d, P must rise.
2.
a.
Laspeyres index of output
Pold*Qold = 10,000*100 + 20*10,000 + 25*5,000 = 1,325,000 - an index of 100
Pold*Qnew = 10,000*110 + 20*20,000 + 25*6,000 = 1,650,000 – an index of 124.5
Growth in output = (1650-1325)/1325 = .245 or 24.5%
b.
Paasche index of output
Pnew*Qold = 14,000*100 + 12*10,000 + 50*5,000 =1,770,000 – an index of 100
Pnew*Qnew = 14,000*110 + 12*20,000 + 50*6,000 = 2,080,000 – an index of 117.5
Growth in output = (2080-1770)/1770 = .175 or 17.5%
c.
3.
chain index of output
SquareRoot [1.175*1.245] - 1 = .209 so growth in output = 20.9%
Based on the data in the table, the results would be as follows:
Unemployment Rate = 100*(CLF – Employment)/ CLF = (2892-2782)/2892*100=3.8%
Employment Rate = 100 – Unemployment Rate = 96.2%
Employment Ratio = 100*Employment/ Civilian non-institutional Pop =
100*(2782/3510) = 79.3%
Labor Force Participation Rate = 100*CLF/ Civilian non-institutional Pop = 100*2892/
3510) = 82.4%
Severity Index = 5*Unemployment Rate*Mean Duration = 5*(.038)*14.9 = 2.83 Days
4a.
From Y = C + I + G + eX –Im , we can determine that
eX = 4500 -2500-1000 -1000 + 450 = 450
Since I + G + eX = S + T + iM, we can determine that
S = 1000 + 1000 + 450 -800 – 450 = 1200
The Trade Balance = eX – iM = 450 – 450 = 0; thus, there are no capital inflows or
outflows. The excess of savings over investment (200) funds the excess of governmental
spending over taxation.
b.
Expansionary fiscal policy would need to be funded either by a reduction in
investment, a reduction in consumption, or a decrease in exports.
5a.
Increase in payroll employment reflects the ability of firms to absorb growth in
the labor force. Since the labor force grows by roughly 1% per year (See Econ Report of
the President and class discussion), we need to add about 1% to payrolls each year.
Given that payroll employment is around 146 million people, we need to add 1.46 million
per year or roughly 122 thousand per month. 188 thousand is, thus, a very positive sign.
An unemployment rate of 4.4% lies below the unemployment rates we have seen in
recent years. Estimates of full employment or the natural rate (5.5%) as posited by
Mankiw in Chapter 6 suggest that 4.4% is below relevant benchmarks. This implies that
such a low rate is not sustainable. If the NAIRU (non-accelerating inflation rate of
unemployment) notion is 5% or higher, 4.4% might suggest rising inflation is on the
horizon. Consequently, this news cannot be viewed as uniformly positive.
b.
Payroll employment may not be an accurate indicator because it double counts
people who exist on two payrolls and does not count self-employed or many who work
for very small firms. The published unemployment rate (U3) captures those in the labor
force and available and ready to work. It can be influenced by temporary jobs,
movement into and out of the labor force, the benefits available to those unemployed, and
the reservation wage.
6a.
In the Neo-Classical Model, the only reason to hold money is to purchase goods
and services. Such a desire to purchase is based on income that people have. Since
income is determined on the supply side and since aggregate demand only influences the
price level, changes in the stock of money have no influence on real variables including
GDP, real wages, employment, investment, and consumption.
b.
Each measure of money conveys something different about the level of liquidity
in the economy. The narrowest measure, M0 - currency plus reserves, provides some
indication of what the central bank has direct control over. A broad measure, such as M2
which includes currency, demand deposits and a variety of other depository accounts,
reflects assets that people can cash reasonably quickly and thus use for current
purchasing. Furthermore, the velocity of M2 with respect to nominal GDP seems
untrended which means that it has some desirable stability characteristics.
7a.
One can calculate GDP by a) determining what it would cost to purchase all
goods that were produced for final sale, b) determining the incomes paid to all factors of
production plus depreciation allowances and indirect business taxes, or c) by adding
together the value added at each stage in the production process. The first two are
equivalent since they count opposite sides of the same transaction. For every transaction
there would be both income and expenditure representation: double – entry bookkeeping.
The value added approach looks at all stages of production rather than just goods
produced for final sale. But, the sum of the values added for a given item equals its final
sales value without double counting; thus, total expenditures on goods for final sale is
equivalent to the sum of all values added.
b.
GDP does a better job of measuring economic welfare in advanced industrialized
countries than it does in less developed economies because more goods flow through
markets. To the degree goods are not recorded in the market place, GDP will undercount
economy activity and, thus, economic welfare. An economy that only features barter will
not show any recorded market activity. Additionally, some items add to economic
welfare – for example, less pollution - but are not recorded as part of GDP. In contrast,
the generation and clean-up of pollution both add to GDP, but the net addition to
economic welfare would be zero. Protective expenditures (police and fire) have similar
characteristics.
Purchasing power parity (PPP) refers to the idea that traded goods should sell for the
same price in all countries; thus, the exchange rate between any pair of currencies should
adjust to ensure that this “law of one price” holds. Since the cost of living in relatively
poor countries would be lower than would exist in relatively wealthy countries, PPP
calculations would raise the calculated GDP in terms of a common exchange rate (such as
the dollar and, thus, would more accurately represent material well-being than
calculations based on market exchange rates alone.