Homework#7 Section: ~~~~~~~~~

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1 Elements of Macroeconomics: Homework#7 Section: ~~~~~~~~~ 1. Lolaland's output grows 3% per year. Lolaland's labor hours grow 1% per year. Lolaland's average hourly wages grow 3% per year. What is the rate of change for unit labor costs in Lolaland? oi.jp..j:. ivicif'e«-se..s.riø î "4.J.. ta.-~ e, b. (t,'v<-ca- ~ =-s, Í'., + -s. i;, =- 4-i., ~ L(_,,\ 1.. ~ {Jr.Ar ~ h ~~(l._ li: 2. Menaceville's output grows 2% per year. Menaceville's labor hours grow 1 % per year. Menaceville's average hourly wages grow 3% per year. What is the yearly rate of change for unit labor costs in Menaceville? 3. Suppose that in 2020 Menaceville and Lolaland have equal unit labor costs, and both set at an index level of 100. In 10 year's time, given the treajectories described above, what are their respective unit labor cost levels? M ~V ;U.e.. 'º l OO X I-öl. Il, o L<>LJ J I e, (OO k' l O( I 10

2 4. Given the change in ULC, what might have happened to the bilateral trade positions of the two nations, over the ten years? Explain. If fk- (b.;lc;~e_ nje-.-~ijl.-i'l0 s {.J/t~/ Aef,ct~~ ;11 11~,-tJ e- ~: fj, IA--t:-4-~e.- 1~ ct.i:: ~~ ~Q/- ~ ilreíâ.~(/(_ c>-.-.tl- u.: ~+s ~e r ~vf 5. The Lalaland currency is the$. Menaceville is the. In $ = 1. Use a drawing to show whatlikely happened to the exchange rate. Brielfly explain why. Tl_ 11 0-ff'"e-cttÀ~ ~ f ~ L. I"\ J1 ~ tj-<:jl V; {Lz_ b~ j fo rs.?~e_ ~ LhW 6. How might this effect Menace ville's borrowing costs? I /1-c ~~ fl..,,j t1~v:fle_ ft:j

3 7. Menaceville and Lalaland agree to form a currency peg, and share one central bank. Over time what new [problem will arise? U.S. t-note, issue date 1/05/17, repayment date 1/05/18, price $100 U.S. t-note, issue date 1/05/17, repayment date 1/05/19, price $100 yield 1.0% yield 1.5% A) What does Lola believe the ex-ante real yield is on the 2-year note? p> ~ ~~,.._J ~,'Jj_ [xre-c:à: Ule. ~ -C"xe- s 1% /~e-" ~ bte.-c~ I~,, ;~l.:lr'o.,, '::" Ô Çi:, B) Suppose inflation averages 2% over the next two years. What was the ex-post real yield on the 2-year note? C) What do market participants, on average, expect the 1-year yield will be, in 2018? (ignore term premia considerations) )(::. 2 ;%, D) If inflation turned out to be 3% in 2017, would you expect that the government would have to offer a higher or lower interest rate to borrow money for 1-year, in 2018? And if Lola bought the 2-year note, at a price of 1 OO, and went to sell it in 2018 would the payment she collected likely be higher or lower that 100? Briefly explain: PJe_ ~"" o I e. f1 :,i..,... I~ tu~ ~,,JJt,lf_J. ~.-(1 k-o..,,ve ÏvL..eAe-v-çeJt v--a..--s~f~ Î"\ jt(..-ve,st~..s ~~-L ~ '- L ~i... ri é>h.-...j. ~ ~ell. (!)t 2 ~~ t\rjtt ç)j 1JQ....a.s+ ~QS ~&Î ~

4 E) Lola now looks at a Bloomberg screen that provides information about the characteristics of a number of corporate bonds: IBM note, SnorXnote, issue date 1/05/17, repayment date 1/05/19, price $100 yield 2.5% issue date 1/05/17, repayment date 1/05/19, price $100 yield 5.5% i) Explain why SnorX must pay a higher rate than IBM, to borrow for 2 years, and why both Snorx and IBM pay more than the gvoemment to borrow money over the same period. bo 1Í. taj e- t- r-s.jc) s" >r- x '> t-,'-e.«,'~ n.:, tf1 ii) Suppose a trade war erupts between China, Europe and the USA. Suppose further that this looks likely to badly hurt economies around the Globe. a) Thej rice e 2-year t-note likely (circle one answer) goes down b) The price of the 2-year IBM note likel ( circle one answer) Goes up Goes down alot c) The price of the 2-year SnoreX note likely ( circle one answer1..---:::=--..,-..._ Goes up Goes down

5 Section li The charts below depict lending and borrowing for the U.S. economy in late 2015:! Ji~ t (;Ç' ~ '1 '"' -,.- - -~ -" ~---,.L~-~ - ' --~ The two quadrants above depict the U.S. loanable funds markets in Label the curves and identify, on the graph, the equilibrium real corporate borrowing rate and the equilibrium quantity of lending to U.S. corporations. Likewise, identify the equilibrium quantity of borrowing by the U.S. government, and the equilibrium interest rate that households receive. Whatisthespreadbetweenthetwoequilibriumborrowingrates? $'.pt~:.:. "S-O S-:::. l Ç% Suppose Hillary Clinton is elected President and the Democrats take control of Congress. President Clinton enacts a very large increase in government spending, with small tax increases on the wealthy. The U.S. government, in 2017, needs to borrow 50% more than they did in ln 2016 inflation is 1.5%. ln 2017, inflation is 2%. a) ln the government quadrant, adjust the picture to represent the change in government policy. Identify the new equilibrium interest rate, and the new equilibrium level of lending to the government. b) We now have a new equilibrium rg. How will that affect the loanable funds market for corporations?

6 c) Given rg, draw in the change you expect to see, in the corporate loanable funds market. d} If nothing else changes, will corporations be investing and borrowing more or less? What do economists label this change in private investment, in reaction to a change in government borrowing? n Les.s ~..,. e) But wait! Suppose Clinton's stimulus plan also bolsters corporations' confidence. Suppose businesses sense a stronger recovery, because of the increase in government spending. Suppose this lifts corporate spirits and companies ramp up investment, so that their investment and borrowing are higher in 2017, than they were in Draw the necessary additional curve shift, so that your cha rt depicts both effects. f) Suppose you looked on a Bloomberg screen in 2016, and again in What would the interest rate be that the government paid, to borrow money from households in 2016? What would the interest rate be in 2017? 2ö {,6 : ö Ç l'j J.. I s /'-(.~~!>"\ - ~2% 2-e /7.ç "J.i: z ;o\.;lj r~~ :::.. 'S. _ç-%

7 Section III: The Multiplier in China in 2016: C = C + b=y I = I = 45 G = G = 7 NX = NX = 5 (trillions of yuan) (Note: autonomous consumption =3, MPC = 0.4, Unemployment= U= 5%, Unemployment at 5% is considered an ideal level for unemployment) l. We need to first depict China in Aggregate Expenditure space. Use the graph below: 7 a) Label axes, draw line that identifies equilibrium values. b) Draw consumption e) Draw consumption plus investment d) Draw consumption + investment + government + net exports e) Identify ye

8 2. Derive, algebraically, ye 4-ç + 1-.f- s; +- o-4- te ~ Q- 0 4-) ( } o 3. Suppose Chinese government officials determine that investment in China is now grossly excessive. Suppose these officials tell banks to halt lending to real estate developers, and I falls dramatically. Suppose by 2018, China is now in a new equilibrium position, one with investment now at 35 trillion yuan. b) Is the level of consumption, when equilibrium is reached in 2018 higher or lower and by how much? e) What happened to unemployment in China? Stable? Up a little? Up a lot? Briefly explain: Up o(_ tot. '" c L- k ~rj-. <(_ Ll/ ~º

9 d) Suppose you are a Chinese economist reporting to the Politburo, the governing body in China. You recognize, ex-ante, that a big drop for investment will have brutal effects on China, IF NOTHING ELSE IS DONE. You know that the rest of the world will protest and trade wars will start if you try and drive NX sharply higher. You know the government has already built many roads and bridges and bullet trains. You decide that stronger consumption is key. Y ou explain to your bosses that China's consumers have an extremely high MPS, relative to rest of the world. You note that this reflects the teeny social safety net that exists in China. Y ou point out that in the USA and Europe, old people collect social security payments and get free medical care, and this gives them confidence to spend much of what they earn as young people. You propose the creation of similar old age promises to China's workers. You argue that China's young workers, if they come to believe they will be cared for in their old age, will feel more confident about spending their current income. Y ou go one step further. Y ou assert that your programs will cause the MPC to rise to precisely the level needed to keep the economy at the 2016 equilibrium level. i) What's the new MPC that will keep the economy at the 2016 equilibrium level, despite the fall for investment described above? (show work) t eo.: ~ + ~.s..,. l -t s.- + f1 Ft:.- -"' too ii) Fill in the table below, to use to show politburo members why your idea makes good sense: ~~- ~ -- -~--.---,-~~- ---,~--'~ j y~... 1.J._3L_J... _fvl l.-~ ( o O : li!. '1- I $'" i 5% - -~~~=~ ~+-~ ~ ' -.., '. ~ ' ~-~ r~ -,~ ---~--~,~,--~--~~-~l,;;,;;n,,;;,.ve.;;;.;;; anges I 2018! 5" J.,(, "\ -~ MO!,.,_,,.~ C t~~-... ~~~~, ~-l ~ '" - ",;; ~~ MPC and investment [changes I 2018 I / o o S 3 ~ 5'"?2- Ç. IV" 5:1.

10 Section 4: Long Term Sustainable Growth ~r 1 = ~~ J\.~~UALIZED IGROWTH!. I~~~.... J (DECADE TOI DECADE) ~J!~ ,300 L , ~ -.. ~. INDIA l 1, TO 95 I 1~1~9~9,s~~- ""-., _ ~- ~- ~.. _. ~ t I ß ~ : : ~ 3 48,760 I 2,720 1, TO 05 I 3. ß~~. 4-1S 51,490 j 6,420, ~1, OSTO 15 j. ó S Of ô 6 O Consider the two tables above; 1. Fill in the decade-to-decade annualized growth rates in the second table. 2. Output per person is close to output per hour. What do ~ p,,,j.., {,',,, ': 3. What are the three components of output per hour? Tee-Æ.to(t>ßj,, c <);f~.j.{,-,c-cm C, «1._ 4. Which of the three components likely explain the differential growth rates, between USA, China and India over the past 30 years? 5. Suppose all three nations embrace strong growth as their goal and all three make intelligent decisions over the next 20 years. Which of the three nations is likely to witness the slowest GDP/capita growth and which is likely to achieve the fastest GDP/capita growth? Explain: ~L t~f~1:-~ 6. In 2035, all three nations 'did the right things' are they likely to have comparable GDP/capita growth rates or very different GDP/capital growth rates? (Hint: think Romer and non-excludable, non-rival goods)

Elements of Macroeconomics: Homework #4. 1. Households supply loanable funds to firms and the government.

Elements of Macroeconomics: Homework # Due 0/08 or 0/09 in assigned Section Name: Section: Section I Fill in the blanks. Households supply loanable funds to firms and the government.. Equilibrium in the