An economy has the following equation for the Phillips curve: π = Eπ - .5(u - 6) People form expectations of inflation by taking a weighted average of the previous two years of inflation: Eπ= 0.7 π-1 + 0.3 π-2 Okun’s law for this economy is: (Y 2 Y21)/Y21 5 3.0 2 2.0 (u 2 u21) The economy begins at its natural rate of unemployment with a stable inflation rate of 5 percent. a. What is the natural rate of unemployment for this economy? b. Graph the short-run tradeoff between inflation and unemployment that this economy faces. Label the point where the economy begins as point A. (Be sure to give numerical values for point A.) c. A fall in aggregate demand leads to a recession, causing the unemployment rate to rise 4 percentage points above its natural rate. On your graph in part (a), label the point the economy experiences that year as point B. (Once again, be sure to give numerical values.) Aggregate Supply and the Short-Run Tradeoff Between Inflation and Unemployment | 433 d. Unemployment remains at this high level for two years (the initial year described in part (c) and one more), after which it returns to its natural rate. Create a table showing unemployment, inflation, expected inflation, and output growth for 10 years beginning two years before the recession. (These calculations are best done on a computer spreadsheet.) e. On the same graph you used in part (b), graph the short-run tradeoff the economy faces at the end of this 10-year period. Label the point where the economy finds itself as point C. (Again, use numerical values.) f. Compare the equilibrium before the recession with the new long-run (period ten) equilibrium. How much does inflation change? How many percentage points of output are lost during the transition? What is this economy’s sacrifice ratio?
> Explain whether borrowing constraints increase or decrease the potency of fiscal policy to influence aggregate demand in each of the following cases. a. A temporary tax cut b. An announced future tax cut
> A central bank has a new head, who decides to increase the response of interest rates to inflation. How does this change in policy alter the response of the economy to a supply shock? Give both a graphical answer and a more intuitive economic explanation
> Country A and country B both have the production function Y = F(K, L) = K1/3L2/3. a. Does this production function have constant returns to scale? Explain. b. What is the per-worker production function, y = f (k)? c. Assume that neither country experienc
> The sacrifice ratio is the accumulated loss in output that results when the central bank lowers its target for inflation by 1 percentage point. For the parameters used in the text simulation (see the FYI box), what is the implied sacrifice ratio? Explain
> Explain the differences between demand-pull inflation and cost-push inflation.
> According to the rational-expectations approach, if everyone believes that policymakers are committed to reducing inflation, the cost of reducing inflation—the sacrifice ratio—will be lower than if the public is skeptical about the policymakers’ intentio
> What are the advantages of floating exchange rates and fixed exchange rates?
> The Mundell–Fleming model takes the world interest rate r* as an exogenous variable. Let’s consider what happens when this variable changes. a. What might cause the world interest rate to rise? (Hint: The world is a closed economy.) b. If the economy has
> This appendix considers the case of a large open economy with a floating exchange rate. Now suppose instead that a large open economy has a fixed exchange rate. That is, the central bank announces a target for the exchange rate and commits itself to adju
> Describe the possible effects of falling prices on equilibrium income.
> An economy is initially described by the following equations: C = 500 + 0.75(Y - T) I = 1,000 + 50r M/P =Y - 200r G = 1000 T = 1000 M = 6,000 P = 2 a. Derive and graph the IS curve and the LM curve. Calculate the equilibrium interest rate and level of in
> Why does the LM curve slope upward?
> Consider the impact of an increase in thriftiness in the Keynesian cross model. Suppose the consumption function is C = C + c(Y - T), where C is a parameter called autonomous consumption that represents exogenous influences on consumption and c is the
> What determines the natural rate of unemployment?
> Explain the impact of an increase in the money supply in the short run and in the long run.
> The official arbiter of when recessions begin and end is the National Bureau of Economic Research, a nonprofit economics research group. Go to the NBER’s Web site (http://www.nber .org) and find the latest turning point in the business cycle. When did it
> How can policymakers influence a nation’s saving rate?
> Prove each of the following statements about the steady state of the Solow model with population growth and technological progress. a. The capital–output ratio is constant. b. Capital and labor each earn a constant share of an economy’s income. [Hint: Re
> In the Solow model, how does the rate of population growth affect the steady-state level of income? How does it affect the steady-state rate of growth.
> “Devoting a larger share of national output to investment would help restore rapid productivity growth and rising living standards.” Do you agree with this claim? Explain, using the Solow model.
> Is most unemployment long-term or short term? Explain your answer.
> Suppose that Congress passes legislation making it more difficult for firms to fire workers. (An example is a law requiring severance pay for fired workers.) If this legislation reduces the rate of job separation without affecting the rate of job finding
> If a small open economy bans the import of Japanese video game systems, what happens to saving, investment, the trade balance, the interest rate, and the exchange rate?
> What will happen to the trade balance and the real exchange rate of a small open economy when government purchases increase, such as during a war? Does your answer depend on whether this is a local war or a world war?
> Answer the following questions about your own experience in the labor force. a. When you or one of your friends is looking for a part-time job, how many weeks does it typically take? After you find a job, how many weeks does it typically last? b. From yo
> If inflation rises from 6 to 8 percent, what happens to real and nominal interest rates according to the Fisher effect?
> Suppose that the money demand function takes the form (M/P)d 5 L(i, Y ) 5 Y/(5i) a. If output grows at rate g and the nominal interest rate is constant, at what rate will the demand for real balances grow? b. What is the velocity of money in this economy
> Explain how banks create money.
> In the nation of Wiknam, people hold $1,000 of currency and $4,000 of demand deposits in the only bank, Wikbank. The reserve–deposit ratio is 0.25. a. What are the money supply, the monetary base, and the money multiplier? b. Assume that Wikbank is a sim
> Write a Cobb–Douglas production function for which capital earns one-fourth of total income.
> Suppose that an economy’s production function is Cobb–Douglas with parameter a = 0.3. a. What fractions of income do capital and labor receive? b. Suppose that immigration increases the labor force by 10 percent. What happens to total output (in percent)
> How are the CPI and the PCE deflator similar, and how are they different?
> Place each of the following transactions in one of the four components of expenditure: consumption, investment, government purchases, and net exports. a. Boeing sells an airplane to the U.S. Air Force. b. Boeing sells an airplane to American Airlines. c.
> Use the model of supply and demand to explain how a fall in the price of frozen yogurt would affect the price of ice cream and the quantity of ice cream sold. In your explanation, identify the exogenous and endogenous variables.
> What are adverse selection and moral hazard? How do banks mitigate these problems?
> What are the net capital outflow and the trade balance? Explain how they are related.
> Some commentators argue that when a financial firm is rescued by the government in the midst of a financial crisis, the firm’s equity holders should be wiped out, but the firm’s creditors should be protected. Does this solve the moral hazard problem? Why
> Describe four problems affecting measurement of the government budget deficit.
> The Social Security system levies a tax on workers and pays benefits to the elderly. Suppose that Congress increases both the tax and the benefits. For simplicity, assume that Congress announces that the increases will last for only one year. a. How do y
> Describe the Lucas critique.
> A central bank has decided to adopt inflation targeting and is now debating whether to target 5 percent inflation or zero inflation. The economy is described by the following Phillips curve: u =5 - 0.5 (π - Eπ), where u and π are the unemployment rate an
> Explain why an increase in the interest rate reduces the amount of residential investment.
> The IS–LM model developed in Chapters 11 and 12 assumes that investment depends only on the interest rate. Yet our theories of investment suggest that investment might also depend on national income: higher income might induce firms to invest more. a. Ex
> How do the life-cycle and permanent-income hypotheses resolve the seemingly contradictory pieces of evidence regarding consumption behavior?
> The chapter analyzes Fisher’s model for the case in which the consumer can save or borrow at an interest rate of r and for the case in which the\ consumer can save at this rate but cannot borrow at all. Consider now the intermediate case in which the con
> A central bank has a new head, who decides to raise the target inflation rate from 2 to 3 percent. Using a graph of the dynamic AD–AS model, show the effect of this change. What happens to the nominal interest rate immediately upon the change in policy a
> Use the model of the small open economy to predict what would happen to the trade balance, the real exchange rate, and the nominal exchange rate in response to each of the following events. a. A fall in consumer confidence about the future induces consum
> “If a central bank wants to achieve lower nominal interest rates, it has to raise the nominal interest rate.”
> Why might inflation be inertial?
> In the Mundell–Fleming model with floating exchange rates, explain what happens to aggregate income, the exchange rate, and the trade balance when a quota on imported cars is removed. What would happen if exchange rates were fixed rather than floating?
> A small open economy with a floating exchange rate is in recession with balanced trade. If policymakers want to reach full employment while maintaining balanced trade, what combination of monetary and fiscal policy should they choose? Use a graph, and be
> Suppose that policymakers in a large open economy want to raise the level of investment without changing aggregate income or the exchange rate. a. Is there any combination of domestic monetary and fiscal policies that would achieve this goal? b. Is there
> What is the impact of a decrease in the money supply on the interest rate, income, consumption, and investment?
> Consider the economy of Hicksonia. a. The consumption function is given by C = 300 + 0.6(Y - T).The investment function is I = 700 - 80r. Government purchases and taxes are both 500. For this economy, graph the IS curve for r ranging from 0 to 8. b. The
> Why does the IS curve slope downward?
> Although our development of the Keynesian cross in this chapter assumes that taxes are a fixed amount, most countries levy some taxes that rise automatically with national income. (Examples in the United States include the income tax and the payroll tax.
> If a war broke out abroad, it would affect the U.S. economy in many ways. Use the model of the large open economy to examine each of the following effects of such a war. What happens in the United States to saving, investment, the trade balance, the inte
> Why does the aggregate demand curve sloped downward?
> Let’s examine how the goals of the Fed influence its response to shocks. Suppose that in scenario A the Fed cares only about keeping the price level stable and in scenario B the Fed cares only about keeping output and employment at their natural levels.
> What data would you need to determine whether an economy has more or less capital than in the Golden Rule steady state?
> In the United States, the capital share of GDP is about 30 percent, the average growth in output is about 3 percent per year, the depreciation rate is about 4 percent per year, and the capital–output ratio is about 2.5. Suppose that the production functi
> Suppose an economy described by the Solow model is in a steady state with population growth n of 1.8 percent per year and technological progress g of 1.8 percent per year. Total output and total capital grow at 3.6 percent per year. Suppose further that
> Might a policymaker choose a steady state with more capital than in the Golden Rule steady state? With less capital than in the Golden Rule steady state? Explain your answers.
> Consider an economy described by the production function: Y = F(K, L) = K 0.4L0.6. a. What is the per-worker production function? b. Assuming no population growth or technological progress, find the steady-state capital stock per worker, output per worke
> Give three explanations of why the real wage may remain above the level that equilibrates labor supply and labor demand.
> In this chapter we saw that the steady-state rate of unemployment is U/L= s/(s + f ). Suppose that the unemployment rate does not begin at this level. Show that unemployment will evolve over time and reach this steady state. (Hint: Express the change in
> If a small open economy cuts defense spending, what happens to saving, investment, the trade balance, the interest rate, and the exchange rate?
> Write the quantity equation and explain it.
> Explain the difference between macroeconomics and microeconomics. How are these two fields related?
> The frame-welding department of a large automotive company welds car frames as they pass down the assembly line. Four computer-controlled robots make the welds on each frame simultaneously. When installed last year, each robot was expected to have a five
> Auden Manufacturing produces a single product with the following standards: Standard direct labor cost per unit…………………………………….. $2.00 Standard direct materials per unit ……………………………………… $3.00 Flexible overhead budget ………………………………………………… $60,000 Normal p
> An investment opportunity that will involve an investment of $1,000 will generate $300 per year for five years and then earn $140 per year forever. What is the net present value of this investment, assuming the interest rate is 14 percent?
> The purchasing department of Bradley Inc. is responsible for companywide purchasing. Its total costs are assigned to each division based on the number of purchase orders the purchasing department processes for each division. The purchasing department’s f
> Ultrasonic manufactures three ultrasound imaging systems: Avex, AvexII, and Mel. Overhead is allocated to each system based on standard direct material dollars in each system. The firm uses a flexible overhead budget to calculate the overhead rate for th
> Your firm uses return on assets (ROA) to evaluate investment centers and is considering changing the valuation basis of assets from historical cost to current value. When the historical cost of the asset is updated, a price index is used to approximate r
> Digital Convert (DC) is a three-year-old start-up company with most of its capital coming from banks and personal investments by the founders. DC manufactures a high-resolution scanner (MXP35) for professional photographers that scans 35-mm negative film
> An October 25, 1999, article in BusinessWeek by D. Brady, “Why Xerox Is Struggling,” reported: President and Chief Executive G. Richard Thoman is a big-picture guy. For the past two years, he has preached a digital revolution at the copier giant. Get dow
> Joon manufactures and sells to retailers a variety of home care and personal care products. Joon has a single plant that produces all four of its product lines: Stick Goods (brooms and mops), Floor Care(strippers, soaps, and waxes), Brushes (hair brushes
> The owner of a small software company felt his accounting system was useless. He stated, “Accounting systems only generate historical costs. Historical costs are useless in my business because everything changes so rapidly.” Required: a. Are historical c
> IPX is a specialized packaging company that packages other manufacturers’ products. Other manufacturers ship their products to IPX in bulk. IPX then packages the products using high-speed, stateof-the-art packaging machines and ships the packaged product
> Discretionary costs are defined as “costs that (1) arise from periodic (usually yearly) appropriation decisions regarding the maximum amounts to be incurred and (2) have no well-specified function relating inputs (as measured by the costs) and outputs (a
> Old Town Roasters (OTR) owns and operates a chain of 12 coffee shops around town. OTR’s strategy is to provide the highest-quality coffee and baked goods in a warm, friendly environment. Each OTR provides its customers Internet access and current newspap
> You are a new consultant with the Boston Group and have been sent to advise the executives of Penury Company. The company recently acquired product line L from an out-of-state concern and now plans to produce it, along with its old standby K, under one r
> Zeflax manufactures insulated plastic bottles for bikes that the company sells for $4.00 per bottle. Last year the company produced 230,000 bottles and sold 200,000 bottles. This year Zeflax produced 200,000 bottles and sold 230,000 bottles. In both year
> Outback Opals mines and processes opals from its Australian opal mines. The process consists of removing large chunks of stones, carefully splitting the stones and removing the opals, and then cutting and polishing the stones. Finally, the opals are sort
> Slawson is a publicly traded Argentine company with three operating companies located in Argentina, the United States, and Germany. Slawson’s corporate headquarters in Buenos Aires oversees the three operating companies. The annual cost
> Rogers Petersen and Cabots are two of the five largest investment banks in the United States. Last year there was a major scandal at Cabots involving manipulation of some auctions for government bonds. A number of senior partners at Cabots were charged w
> Critically discuss the following quotation: ABC (activity-based cost) information, by itself, does not invoke actions and decisions leading to improved profits and operating performance. . . . For ABC systems to be effective, everyone in the company—from
> Phipps manufactures circuit boards in Division Low in a country with a 30 percent income tax rate and transfers them to Division High in a country with a 40 percent income tax. An import duty of 15 percent of the transfer price is paid on all imported pr
> Black Feather Indian Nation is a 900 square-mile territory in North Dakota that has the legal right to sell gasoline without having to collect or pay state and federal taxes on it. Gasoline in North Dakota sells for $1.20 per gallon, which includes $0.50
> Guest Watches is a division of Guest Fashions, a large, international fashion designer. Guest Watches manufactures highly stylish watches for young adults (age 18 to 30) who are fashion conscious. It is a profit center and its senior managementâ
> Dr. Lucy Zang, a noted local podiatrist, plans to open a retail shoe store specializing in hard-to-find footwear for people with feet problems such as bunions, flat feet, mallet toes, diabetic feet, and so forth. Because of the wide variety of foot ailme
> International Computer Company (ICC) has annual revenues of $2 billion primarily from selling and leasing large networked workstation systems to businesses and universities. The manufacturing division produces the hardware that is sold or leased by the m
> The National Direct Student Loan (NDSL) program allows college students to borrow funds from the federal government. The contract stipulates that the annual percentage rate of interest is 0 percent until 12 months after the student ceases his or her form
> Magee Inc. pays its sales manager a bonus of $10,000 if the manager meets the sales quota. The sales manager can exert either high effort or low effort. The additional disutility of the manager in exerting high effort relative to low effort to meet the s
> Panarude Airfreight is an international air freight hauler with more than 45 jet aircraft operating in the United States and the Pacific Rim. The firm is headquartered in Melbourne, Australia, and is organized into five geographic areas: Australia, Japan
> The Xerox DocuColor iGen3 digital production press is a high volume, on-demand, full-color printer capable of producing up to 6,000 impressions (pages) per hour. It weighs nearly 3 tons, stretches 30 feet long, and holds more than 40 pounds of dry ink. I
> Shady Tree produces two products: M1 and M2. There are no beginning inventories or ending working-process inventories of either M1 or M2. A single plant wide overhead rate is used to allocate overhead to products using standard direct labor hours. This o
> Anpax, Inc., manufactures two products: L7 and Q2. Overhead is allocated to products based on machine hours. Management uses a flexible budget to forecast overhead. For the current year, fixed factory overhead is projected to be $2.75 million and variabl
> Darien Industries operates a cafeteria for its employees. The operation of the cafeteria requires fixe costs of $4,700 per month and variable costs of 40 percent of sales. Cafeteria sales are currently averaging $12,000 per month. Darien has an opportuni
