Download Macroeconomic Theory

Macroeconomic Theory
M. Finkler
Suggested Answers to Spring 2003 Midterm Examination #1
1.
a.
To complete the model, we need the following:
Labor equilibrium statement
LS = LD = L
Goods market equilibrium statement
Y = AD
Money market equilibrium statement
Md = M
Definition of aggregate demand (optional) AD = C + I + G
b.
The reduced form statement for output comes from the LS, LD, and labor
market equilibrium statement:
LS = 2,400 +20*(W/P) - 10*T = 1,000 – 10*(W/P)+ 5*K = LD
We can solve this equation for W/P as follows:
30*(W/P) = -1400 + 5*K + 10*T which implies that
W/P = (-1400 + 5*K + 10*T)/30
Now plug into either equation (I’ll use LD) to yield
1,000 – 10*(-1400 + 5*K + 10*T)/30 = LD
so L=LD=LS =1466 2/3– (500/30)*K – (100/30)*T
Y = 100*L.7K.3 with L above.
c.
For T = 100, K = 200, and M = 100,000,
W/P = (-1400 + 5*200 + 10*100)/30 = 20
L = 1,000 – 10*(20)+ 5*(200) = 1,800
Y = 100*(1800)7(200).3 = 93,111
P = 10*M/Y = 10*100,000/93,111 = 10.74
d.
An increase in taxes T reduces L from the L reduced form statement (and
because of the backward shift in the LS curve. Since L falls, so does Y. If Y
falls, from the goods market equilibrium statement, P rises.
e.
A decrease in the velocity of money only affects the goods market equilibrium
and not the amount of employment or output. A decrease in velocity would
mean that .1 in the equation rises; thus, P would fall to match given levels of Y
and M.
Part 2. 1a.
The Paasche index for prices uses the current quantity to calculate the
cost of the basket in the current and base years as follows:
Pcurrent = 1.5*40 + 1.8*50 + .8*60 = 198
Pbase = .75*40 + 1.2*50 + .9*60 = 144
Thus prices grew by (198 – 144)/144 = .375 or 37.5%
b.
The Laspeyres index for prices uses the base quantity to calculate the
cost of the basket in the current and base years as follows:
Pcurrent = 1.5*50 + 1.8*40 + .8*60 = 195
Pbase = .75*50 + 1.2*40 + .9*60 = 139.5
Thus prices grew by (195– 139.5)/139.5 = .3978 or 39.78%
c.
The chain weighted index would be computed as follows:
Sqrt ((1+.375)*(1+.3978)) - 1 = .3864 = 38.64%
d.
Use the chain weighted index because the Laspeyres index assumes that
the base year quantities are consumed throughout the period and the
Paasche index assumes that current year quantities are consumed
throughout the period. The chain-weighted index is the geometric
average which is more representative for the entire time period than
either end point basket.
Part 2 2.
a. To determine the trade weighted exchange rate (TWER) for each year relative to 1995,
calculate the ratio of each rate to 1995 for each country (e.g., e90/e95)
Country
Brazil
Canada
US
1990
0.50
2.38
2.67
1995
1.00
1.00
1.00
2000
1.60
0.76
0.73
Now use the weights indicated in the problem:
For 1990, the result would be .25*.5 + .25*2.38 + .5*2.67 = 2.055 or 205.5
For 1995, the result would be 1 or 100 in terms of the problem.
For 2000, the result would be .25*1.6+.25*.76+.5*.73 = .955 or 95.5
Between 1990 and 1995, the TWER, fell by (100-205.5)/205.5 = -.513 = -51.3%
Between 1995 and 2000, the TWER, fell by (95.5 -100 )/100 = -.045 =- 4.5%
b. Growth in REX = nominal exchange growth + P(peso) growth – P(country) growth
Between 1995 and 2000, the real exchange rate for Mexico with Brazil was
(160-100) + 25 - 50 = 35% - rose by 35%
Between 1995 and 2000, the real exchange rate for Mexico with Canada was
(76.2 – 100) + 25 - 8 = -6.8% - fell by 6.8%
Between 1995 and 2000, the real exchange rate for Mexico with the US. Was
((73.3 – 100) + 25 - 11 = -12.7 – fell by 12.7%
c. Since the real exchange rate rose with Brazil, we would expect net exports to fall. For
both the US and Canada, the real exchange rate fell; thus, we would expect net exports to
rise for Mexico with both Canada and the United States
Part 2. 3. a)
Since I = Sp + Sg + Sf, Sf = I – Sp – (T – G). In this question,
Sf = 13 – 18 –(22 – 25) = -2; capital would flow out since S > I
b) If taxes rose by 3 billion dollars, Sg goes to 0, so Sf = -5. As a result, even more
capital would flow out
c) An increase in domestic investment, means that S- I must move towards the real
exchange rate axis; thus, Rex rises and NX falls. Interest rates are unaffected in a
small open economy.
S–I
REX
NX
Net exports
Part III.
1. Crowding out refers to private expenditures reduced as a result of increased governmental
budget deficits. This can be seen from an examination of the loanable funds market. An
increased governmental deficit translates into an increased demand for loanable funds
with consumption and investment both falling to accommodate the increased demand.
LFS
r
LFD + (G-T)
LFD
I1
I0
Loans
The rise in the total loans reflects increased savings that comes from reduced
consumption. If savings are unresponsive to changes in the real interest rate (substitution
effects = income effects), then the LFS curve will be vertical, and only investment will be
crowded out.
2. In a Neoclassical model, investment is a component of aggregate demand, and
aggregate demand has no influence on either employment or output. In the goods
market, neither the AD nor the AS curve would shift. No change would take
place in the labor market in the short run. In the long run, increased investment
changes the stock of capital; thus, labor productivity increases. As a result, the
labor demand curve shifts up, and the aggregate supply curve shifts to the right.
The result would be increased real wages, employment and output.
W/P
Ls
P
AS
AS’
AD
Ld
Ld’
Labor
Output
3.
a.
The official unemployment rate calculates the number of unemployed as
the difference between the number of individuals in the civilian labor force and the
number of people who were employed part-time, full time, or in a family business. To
determine the unemployment rate, this result is divided by the number of people in the
civilian labor force. To be in the civilian labor force, one must be either at work, on
temporary leave from work, or actively looking for work.
b.
The unemployment rate includes a number of people who may just be temporarily
between jobs. U1 and U2 attempt to identify those who have been unemployed for an
extended period of time. U4-U6 recognize that a number of people have either become
discouraged with work or would prefer full time work but have settled for some time of
part time job. The appropriate indicator depends upon what one is attempting to measure.
The official unemployment rate may go up when an economy comes out of a recession
because those who were previously discouraged, begin to job search again.
c.
The natural rate of unemployment refers to the rate of unemployment consistent
with labor market clearing which reflects where the unemployment rate should tend to
over time. It reflects the different between those who are in the job market (at going
wages) and those who have accepted jobs. The natural rate of unemployment changes
with shifts in either the labor supply curve or the labor demand curve, and thus, may yield
results quite different from the official measure. Ideally, the natural rate is the
benchmark unemployment rate.