Reference no: EM131023279

I. Binary Choice

Please circle legibly the letter that corresponds to your answer.

1. Suppose you are a macroeconomist interested in building a short-run model of the aggregate economy. Most likely your model will assume that prices are
a. Sticky in the short-run.
b. Flexible in the short-run.

2. Which of the following variables is a flow variable?
a. Wealth
b. Consumer expenditure

3. When calculating real GDP per year using the method outlined in lecture,
a. Prices are allowed to vary while quantities are equal to the base year quantities.
b. Prices are equal to the base year prices while quantities are allowed to vary.

4. The CPI provides a measure of the general price level of
a. All goods and services produced in an economy during a specific time period.
b. Goods and services that consumers typically purchase.

5. Currently the unemployment rate as calculated by the Bureau of Labor Statistics does not include discouraged workers in the unemployed group. What would happen to the unemployment rate if these discouraged workers were reclassified as part of the unemployed instead of being treated as not in the labor force?The unemployment rate would
a. Decrease.
b. Increase.

6. Suppose you are given the aggregate production function for an economy. Furthermore, suppose the amount of available capital increases for this economy. Holding labor constant, this increase in capital will cause the MPK to
a. Decrease
b. Increase

7. Suppose you are given the aggregate production function for an economy. Furthermore, suppose the amount of available technology increases for this economy. Holding labor and capital constant, this increase in technology causes labor productivity to
a. Increase
b. Decrease

8. Holding everything else constant, when the government increases its spending while maintaining the same level of taxation this results in
a. A leftward shift in the supply of loanable funds curve.
b. A rightward shift in the supply of loanable funds curve.

9. In the loanable funds framework with a closed economy, when the interest rate is greater than the equilibrium interest rate this implies that the supply of goods and services is
a. Greater than the demand for goods and services.
b. Less than the demand for goods and services.

10. The Fisher Effect refers to the
a. Relationship between the demand for money and the supply of money and how this relationship determines the price level in an economy.
b. Relationship between the inflation rate and the nominal interest rate.

II. Short Answer/Graphing Questions

Please provide your answer in the provided space. Remember to write legibly and take the time to organize your answer before you begin to write.

For short essay responses please remember to use complete sentences: sentences should have a subject, a verb, proper capitalization and proper punctuation. We reserve the right to lower your graph for responses that are not written in standard English with these components.

1. Provide a formula for the National Income Accounts Identity using the expenditure approach in the space below.

Suppose that American exports decrease from $1,662 billion to $1,500 billion and at the same time American imports decrease from $2,370 billion to $2,100 billion. All other expenditure components in the American economy during this period of time are unchanged. What is the change in American GDP due to these changes? Show your work in the space below.

2. Fill in the blank for the following two statements:

An approximation for the percentage change in ( ) is ______________________

An approximation for the percentage change in (A/B) is _______________________

Provide an equation giving the relationship between the real wage and the nominal wage. Identify clearly any variable abbreviations you use in this equation.

Use your equation and the relevant approximation technique to provide an approximation of the inflation rate when during the relevant time period the real wage grows by 3 percent while the nominal wage grows by 2 percent. Show your work.

3. Suppose that a Japanese firm buys an existing U.S. firm (located in the U.S. and using American workers) and sends some of its Japanese managers to operate the firm and oversee the American workers. Assume that the firm's output is unchanged, but that the former U.S. managers are now unemployed. Describe the effect of this transaction on U.S. GDP and U.S. GNP in the space below. Be specific in your answer and make sure you explain why the effect occurred.

The effect on U.S. GDP:

The effect on U.S. GNP:

4. Wage rigidity is defined as the failure of wages to adjust to a level at which labor supply equals labor demand. Explain briefly why minimum-wage laws may cause wage rigidity.

5. Suppose that you are analyzing the U.S. economy using a classical long-run model. You see that the U.S. government increases its level of government spending while the level of aggregate output, consumption, net exports, and taxes are held constant. How will this increase in government spending affect the loanable funds market? Explain your answer verbally and illustrate your answer with a graph depicting the effect of this change in the loanable funds market. Be sure your graph is clearly labeled (horizontal and vertical axis, any curve used in the graph, and any equilibrium points) and that you identify the initial equilibrium as well as the equilibrium after the government increases its level of spending. In your answer identify the effect of this change on the real interest rate.

III. Essay/Problem

For the essay response please remember to use complete sentences: sentences should have a subject, a verb, proper capitalization and proper punctuation. We reserve the right to lower your graph for responses that are not written in standard English with these components.

1) Let Y = fK¸ L = AK^αL^{1 - α} be an aggregate production function that maps total capital (K) and labor (L) into output (Y). Parameter α is such that 0 ≤ α ≤ 1. Parameter A represents the level of available technology. Fix α and A for the rest of the problem: leave them as constants in the Cobb-Douglas production function.

A) Characterize the returns to scale of fK¸ L. Explain your answer.

B) Compute the marginal product of capital (MPK; ∂Y/∂K) and the marginal product of labor (MPL; ∂Y/∂L) for fK¸ L. Are they positive or negative?

∂Y/∂K =

The sign of ∂Y/∂K is ______________

∂Y/∂L =

The sign of ∂Y/∂L is ______________

C) Compute the second partial derivatives ∂²Y/∂K² and ∂²Y/∂L² (just differentiate fK¸ L twice with respect to the same variable in each case). If the second partial derivative is negative (positive) this indicates that the first derivative is decreasing (increasing). Given this hint, interpret the significance of the sign of the second derivatives that you have calculated.

∂²Y/∂K² =

The sign of ∂²Y/∂K² is _____________________

∂²Y/∂L² =

The sign of ∂²Y/∂L² is _______________

Interpret the significance of the second derivatives in the space below:

D) Provide a qualitative graph of output (Y) versus the level of capital (K) holding technology (A = A‾) and labor (L = L‾) constant. Output should be on the (vertical) y-axis, and capital should be on the (horizontal) x-axis. Label your axes.

Does the slope of this graph correspond with your result for the sign of ∂²Y/∂K² in part (C)?

E) Assume that factor markets are perfectly competitive, so the factors of production are paid their marginal products. Let's say that it is now the long-run, so all factors of production are fixed, including the level of technology: A = A‾, L = L‾, and K = K‾. What is the long-run equilibrium wage w_e? Show your work.

F) How much is paid to labor (labor income) in long-run equilibrium? What is labor's share of total income?

Labor Income = __________________________________________

Labor's Share of Total Income = _____________________________

G) If you want to predict the long-run distribution of income across factors according to this production theory, what do you need to estimate in terms of parameters? In other words, what variables are needed to compute both capital's share of income and labor's share of income?

H) The following graph was provided by the Federal Reserve Bank of St. Louis. This graph depicts two lines: 1) the total compensation of labor (labor's share of total income) over time and 2) the share of labor compensation over time from wages and salaries.

Shares of National income

Assume that we are in the long-run, with α still fixed. Is this graph consistent with your result from part (F) on labor's share of total income? Think about what should happen over time, not the value.

2) This question takes your knowledge of the article "How Did Economists Get It So Wrong?" by Paul Krugman in The New York Times Magazine as given.

John Cochrane is a professor at the University of Chicago, a "freshwater" school according to Krugman. On 9/16, he published a response to Krugman's article on his website. Here is a short passage from Cochrane's response to Krugman.

"The sad fact is that few in Washington pay the slightest attention to modern macroeconomic research, in particular anything with a serious intertemporal [over time] dimension. Paul's simple Keynesianism has dominated policy analysis for decades and continues to do so ... everyone just adds up consumer, investment and government "demand" to forecast output and uses simple Phillips curves to think about inflation. If a failure of ideas caused bad policy, it's a simpleminded Keynesianism that failed."

Please write a few paragraphs discussing Krugman's assertions in his article and Cochrane's response to those claims. You should briefly address the following questions:

I. What was Krugman's problem with economic policy before the recession?

II. What type of economic policy did Krugman argue for? Why use this policy?

III. According to Cochrane (see the above quote), what type of economic policy is really used? Why is it flawed?

IV. For each author, what was the cause of the recession? Contrast their views.