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 experiences population growth nor technological progress and that 20 percent of capital depreciates each year. Assume further that country A saves 10 percent of output each year and country B saves 30 percent of output each year. Using your answer from part (b) and the steady-state condition that investment equals depreciation, find the steady-state level of capital per worker for each country. Then find the steady-state levels of income per worker and consumption per worker. d. Suppose that both countries start off with a capital stock per worker of 1. What are the levels of income per worker and consumption per worker? e. Remembering that the change in the capital stock is investment less depreciation, use a calculator (or, better yet, a computer spreadsheet) to show how the capital stock per worker will evolve over time in both countries. For each year, calculate income per worker and consumption per worker. How many years will it be before the consumption in country B is higher than the consumption in country A?
> According to the neoclassical theory of distribution, a worker’s real wage reflects her productivity. Let’s use this insight to examine the incomes of two groups of workers: farmers and barbers. Let Wf and Wb be the nominal wages of farmers and barbers,
> Describe the two ways the BLS measures total employment.
> Find data on GDP and its components, and compute the percentage of GDP for the following components for 1950, 1980, and the most recent year available. a. Personal consumption expenditures b. Gross private domestic investment c. Government purchases d. N
> Explain how a financial crisis reduces the aggregate demand for goods and services.
> In the Solow model, what determines the steady state rate of growth of income per worker?
> Go to the website of the Bureau of Economic Analysis and find the growth rate of real GDP for the most recent quarter. Go to the website of the Bureau of Labor Statistics and find the inflation rate over the past year and the unemployment rate for the mo
> According to the Ricardian view of government debt, how does a debt-financed tax cut affect public saving, private saving, and national saving?
> Find some recent projections for the future path of the U.S. government debt as a percentage of GDP. What assumptions are made about government spending, taxes, and economic growth? Do you think these assumptions are reasonable? If the United States expe
> What is meant by the “time inconsistency” of economic policy? Why might policymakers be tempted to renege on an announcement they made earlier? In this situation, what is the advantage of a policy rule?
> It is an election year, and the economy is in a recession. The opposition candidate campaigns on a platform of passing an investment tax credit, which would be effective next year after she takes office. What impact does this campaign promise have on eco
> Explain why changes in consumption are unpredictable if consumers obey the permanent-income hypothesis and have rational expectations.
> Albert and Franco both follow the life-cycle hypothesis: they smooth consumption as much as possible. They each live for five periods, the last two of which are retirement. Here are their incomes earned during each period: They both die at the beginning
> The text analyzes the case of a temporary shock to the demand for goods and services. Suppose, however, that et were to increase permanently. What would happen to the economy over time? In particular, would the inflation rate return to its target in the
> Under what circumstances might it be possible to reduce inflation without causing a recession?
> Suppose that the economy is initially at a longrun equilibrium. Then the Fed increases the money supply. a. Assuming any resulting inflation to be unexpected, describe any changes in GDP, unemployment, and inflation that are caused by the monetary expans
> Describe the impossible trinity.
> Suppose an economy described by the Solow model has the following production function: Y= K1/2(LE)1/2. a. For this economy, what is f(k)? b. Use your answer to part (a) to solve for the steady-state value of y as a function of s, n, g, and ᵹ. c. Two neig
> Business executives and policymakers are often concerned about the competitiveness of American industry (the ability of U.S. industries to sell their goods profitably in world markets). a. How would a change in the nominal exchange rate affect competiti
> Determine whether each of the following statements is true or false, and explain why. For each true statement, discuss whether there is anything unusual about the impact of monetary and fiscal policy in that special case. a. If investment does not depend
> Suppose that the money demand function is (M/P)d = 800 - 50r, where r is the interest rate in percent. The money supply M is 2,000 and the price level P is fixed at 5. a. Graph the supply and demand for real money balances. b. What is the equilibrium int
> Why is it easier for the Fed to deal with demand shocks than with supply shocks?
> Give an example of an institutional difference between countries that might explain the differences in income per person.
> Two countries, Richland and Poorland, are described by the Solow growth model. They have the same Cobb–Douglas production function, F(K, L)= A K aL1-a, but with different quantities of capital and labor. Richland saves 32 percent of its income, while Poo
> Draw a well-labeled graph that illustrates the steady state of the Solow model with population growth. Use the graph to find what happens to steady-state capital per worker and income per worker in response to each of the following exogenous changes. a.
> Do Europeans work more or fewer hours than Americans? List three hypotheses that have been suggested to explain the difference.
> Consider an economy with the following Cobb–Douglas production function: Y = 5K 1/3L 2/3. a. Derive the equation describing labor demand in this economy as a function of the real wage and the capital stock. (Hint: Review Chapter 3.) b. The economy has 27
> According to the theory of purchasing-power parity, if Japan has low inflation and Mexico has high inflation, what will happen to the exchange rate between the Japanese yen and the Mexican peso?
> In the economy of Solovia, the owners of capital get two-thirds of national income, and the workers receive one-third. a. The men of Solovia stay at home performing household chores, while the women work in factories. If some of the men started working o
> A Case Study in this chapter concludes that if poor nations offered better production efficiency and legal protections, the trade balance in rich nations such as the United States would move toward surplus. Let’s consider why this might be the case. a. I
> List all the costs of inflation you can think of, and rank them according to how important you think they are.
> A newspaper article once reported that the U.S. economy was experiencing a low rate of inflation. It said that “low inflation has a downside: 45 million recipients of Social Security and other benefits will see their checks go up by just 2.8 percent next
> What are the various ways in which the Federal Reserve can influence the money supply?
> In the economy of Panicia, the monetary base is $1,000. People hold a third of their money in the form of currency (and thus two-thirds as bank deposits). Banks hold a third of their deposits in reserve. a. What are the reserve–deposit ratio, the currenc
> What determines consumption and investment?
> Figure 3-5 shows that in U.S. data, labor’s share of total income is approximately a constant over time. Table 3-1 shows that the trend in the real wage closely tracks the trend in labor productivity. How are these facts related? Could the first fact be
> List the three categories used by the Bureau of Labor Statistics to classify everyone in the economy. How does the BLS compute the unemployment rate?
> How often does the price you pay for a haircut change? What does your answer imply about the usefulness of market-clearing models for analyzing the market for haircuts?
> How does the leverage ratio influence a financial institution’s stability in response to bad economic news?
> In the Solow model, how does the saving rate affect the steady-state level of income? How does it affect the steady-state rate of growth?
> In recent years, as described in this chapter, both the United States and Greece have experienced increases in government debt and a significant economic downturn. In what ways were the two situations similar? In what ways were they different? Why did th
> According to the traditional view of government debt, how does a debt-financed tax cut affect public saving, private saving, and national saving?
> Some economists have proposed the rule that the cyclically adjusted budget always be balanced. Compare this proposal to a strict balanced-budget rule. Which is preferable? What problems do you see with the rule requiring a balanced cyclically adjusted bu
> How does a person’s interpretation of macroeconomic history affect his view of macroeconomic policy?
> After every policy meeting, the Federal Reserve issues a statement (sometimes called the press release), which you can find on the Fed’s Web site (http://www.federalreserve.gov/monetarypolicy/ fomccalendars.htm). Read the most recent statement. What does
> List four reasons firms might hold inventories.
> When the stock market crashes, what influence does it have on investment, consumption, and aggregate demand? Why? How
> Use Fisher’s model of consumption to analyze an increase in second-period income. Compare the case in which the consumer faces a binding borrowing constraint and the case in which he does not.
> 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
> 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?
> 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)/Y2
> 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?
