ECON3301 SMU-Sobey SB-Fall Comment on the shortcomings of the current methods to measure economic growth.

Transcription

1 ECON01 SMU-Sobey SB-Fall 2011 Midterm Preparation: Short Answer Questions Chapters 1-4 and 6 Dr. Maryam Dilmaghani To be discussed in Oct. 20 th Answer the following questions, be brief but complete. Provide a figure if necessary. 1. How Economic Growth is measured? 2. Comment on the shortcomings of the current methods to measure economic growth.. What can you tell about the relationship between Economic Growth and Income Inequality? What do you know about Canadian situation? 4. What is GDP? How is it measured? 5. To study economic growth for a given country through time and among different countries, what are the adjustments to be made over nominal GDP? 6. Briefly explain what you know about the differences between economic schools of thought. 7. Briefly explain what you know about the currently prevalent Macroeconomics (RBC (real business cycle). 8. What are the main differences between Keynesian Macro and RBC (real business cycle) Macro? 9. What is the main difference between Keynesian Macro and RBC (real business cycle) Macro with respect to monetary policy? 10. What is the main difference between Keynesian Macro and RBC (real business cycle) Macro with respect to fiscal policy (government intervention)? 11. What are the exogenous variables in Solow Growth Model? 12. In Solow Growth Model, what are the determinants of Steady State (long-run equilibrium) values? Page 1 of 2

2 ECON01 SMU-Sobey SB-Fall In Solow Growth Model, what are the determinants of Steady State (long-run equilibrium) values? 14. In Solow Growth Model, what is the impact of immigration of work-force in the short-run as well as on Steady State (long-run equilibrium) values? 15. In Solow Growth Model, what is the impact of change in saving rate in the short-run as well as on Steady State (long-run equilibrium) values? 16. In Solow Growth Model, what is the impact of technological progress in the short-run as well as on Steady State (long-run equilibrium) values? 17. What can you tell about the shortcomings of Solow Growth Model? 18. What are the exogenous variables in our basic General Equilibrium Model? 19. What are the endogenous variables in our basic General Equilibrium Model? 20. In our basic General Equilibrium Model, what is the impact of technological progress? 21. In our basic General Equilibrium Model, what is the impact of a change in saving rate? 22. In our basic General Equilibrium Model, what is the impact of a change in population level? 2. Explain how the Real Wage is determined in our basic General Equilibrium Model. 24. Explain how the Real Rental is determined in our basic General Equilibrium Model. 25. What is the difference between Partial Equilibrium and General Equilibrium? Good Luck! MD Page 2 of 2

3 ECON01 Fall 2011 SMU-Sobey SB ECON01: Intermediate Macroeconomics Problem set for Economic Growth, Chapters 1-4. Dr. Maryam Dilmaghani To be discussed on October 18 th, reading prior to the lecture is advised. Part A. Luggnagg is an island kingdom, one of the imaginary countries visited by Gulliver in the satire Gulliver's Travels by Anglo-Irish author Jonathan Swift. According to Swift, Luggnagg is located one hundred leagues southeast of Japan. It has two principal ports and has commerce with Japan. The inhabitants of Luggnagg, struldbrugs, are immortal but they grow old as a result suffering from infirmities of old age. See: ***&*** In Luggnagg, the output is produced using Labour and Capital, with the production function below: Y = F(L, K) = AL α K β with 0 < α, β < 1 and α + β = 1 Answer the following questions. 1. Re-state the production function in per worker terms. y = Y L = ALα K β L = AKβ L = A Kβ = Akβ 1 α Lβ Note that α + β = 1 β = 1 α Page 1 of 7

4 ECON01 Fall 2011 SMU-Sobey SB 2. Sketch the production function. Y/L. The capital input depreciates in Luggnagg at the rate of δ. The citizens of Luggnagg, are immortal and childless. Since they have no child, they consume 70% of their output Sketch our basic Solow growth model for Luggnagg, showing both output and saving. Notation * (or in some texts SS) mean Steady State Level (i.e. long-run equilibrium level). Output (Y/L)* K/L Y/L C* Consumption δ(k/l) s(y/l)* 0.(Y/L) (K/L)* K/L Note that since 70% of output is consumed, the saving rate is 0. (0%). Page 2 of 7

5 ECON01 Fall 2011 SMU-Sobey SB 4. Recall that the citizens of Luggnagg, are immortal and childless but also they grow old. Now consider the fact that As a result of aging, their willingness to work falls. How would you modify our basic Solow growth model to correspond to the case of Luggnagg? Explain. One way to incorporate this issue in the Solow model is to regard it as depreciation of labor force, in a manner comparable with the depreciation of capital: recall that depreciation of capital input means that just because time passes, parts of invested capital is lost. One can also see depreciation of capital inputs as the invested physical capital (such as machinery) grows old. Let us use μ as the rate of depreciation of labor (human capital). Then the Solow growth model figure can be depicted as below. Output K/L Comparing the figure with the previous one, you see that the steady state level of K/L, physical capital investment per worker: K L, Aggregate saving: s Y, Total Output per worker: L Y L and Consumption: C fall. Standard of living (measured by income per capita) falls. Page of 7

6 ECON01 Fall 2011 SMU-Sobey SB 5. The Bureau of Economic Statistics in Luggnagg has found the increasing number of Very Olds in Luggnagg affects not only the productivity but also the saving rate as a results of the growing needs of the elderly. How do you think this situation affect our basic Solow growth model? What can you tell about the standard of living in Luggnagg? As the saving rate falls the steady state level of K/L, physical capital investment per worker: K L, Aggregate saving: s Y, Total Output per worker: L Y L and Consumption: C fall, as visible in the figure. Output K/L 6. Suppose you are hired to advise the Bureau of Economic Statistics assess the benefits of increasing labor force by 0% through immigration to boost output in Luggnagg. Explain what your response would be and why. Case 1: Immigrant workers are like the residents of Luggnagg in terms of aging Increase in population affects the level of labor input with L, for production functions like: Y = F(L, K) = AL α K β. If the production is specified for Capital per Worker: y = A Kβ L β = Akβ, an increase in population means K. L Page 4 of 7

7 ECON01 Fall 2011 SMU-Sobey SB Output (Y/L)* Y/L C* Consumption δ(k/l) s(y/l)* 0.(Y/L) (K/L)* K/L Increase in population does not affect the production function. Hence, normally the steady state values would remain unaffected, only the position of the economy in terms of K would change as L you see in the figure above. It means that in the long-run, total output and standard of living remains the same. Case 2: Immigrant workers are not like the residents of Luggnagg in terms of aging, the generations replace each other and their population grows In this case, as the original Labour input in Luggnagg is subject to depreciation (through aging), the immigration can help increasing the steady state values (total output and consumption) by reducing the depreciation rate of human capital, as in below. Page 5 of 7

8 ECON01 Fall 2011 SMU-Sobey SB Output K/L Part B. Yutopia is an island kingdom, located one hundred leagues northwest Australia. It has one principal port and has commerce with Australia. The inhabitants of Yutopia, are immortal, eternally young and childless. In Yutopia, output is produced using Labour and Capital, with the production function below: Y = F(L, K) = AL α K β with 0 < α, β < 1 and α + β = 1 Answer the following questions. 1. Re-state the production function in per worker terms. 2. Sketch the production function.. The capital input depreciates in Yutopia at the rate of δ. The citizens of Yutopia, are immortal and childless; hence the population in Luggnagg is constant. Since they have no child, the consume 70% of their output. Using your sketch for the above question, sketch the version of Solow growth model that corresponds to the case of Yutopia. 4. The Bureau of Economic Statistics in Yutopia has found that the standard of living did not improve in the country for the past 10 years. Comment on this observation. Use a figure if necessary. Page 6 of 7

9 ECON01 Fall 2011 SMU-Sobey SB 5. Most experts in Yutopia, suggest that the economic stagnation is caused by the lack of population growth. Comment on this statement. 6. Suppose you are hired to advise the Bureau of Economic Statistics assess the benefits of increasing labor force by 0% through immigration to boost output in Yutopia. Explain what your response would be and why. Part C. Disstopia is an island kingdom, located one in Pacific Ocean. The inhabitants of Disstopia live forever. They are eternally young and childless. In Disstopia, the output is produced using Labour and Capital, with the production function below: Y = F(L, K) = AL α K β with 0 < α, β < 1 and α + β = 1 Answer the following questions. 1. State our basic General Equilibrium model by constructing the budget constraint. 2. Provide a figure for the budget constraint.. Suppose that the residents of Disstopia consume 80% of their total income. Show their consumption and saving choice on your budget constraint figure. 4. Provide a figure for the Labour Market in Disstopia. 5. Suppose that due to a genetic mutation, the residents of Disstopia, though still immortal, start ageing and their productivity falls as they age. (i) How would you modify the production function? (ii) How would you modify your Labour Market figure? (iii) What would be the impact on Real Wage W P? 6. How would you modify your Labor Market figure if you are told that the aging of the residents of Disstopia also negatively affects their willingness to work? (i) What would be the impact on Real Wage W P? (ii) What would be the impact on total real income of the residents of Disstopia? Page 7 of 7

10 ECON01 SMU-Sobey SB-Fall 2011 Midterm Preparation: Short Answer Questions Chapters 1-4 and 6 Dr. Maryam Dilmaghani Answer the following questions, be brief but complete. Provide a figure if necessary. 1. How Economic Growth is measured? See Slides 2, #20 onwards: Mainly through the percentage change in GDP: GDP 2 GDP 1 100, accounting for price changes GDP 1 over time and purchasing power differences among countries 2. Comment on the shortcomings of the current methods to measure economic growth. See Slides-2, # What can you tell about the relationship between Economic Growth and Income Inequality? What do you know about Canadian situation? See Slides-2, #0 onwards 4. What is GDP? How is it measured? See slides-2, # To study economic growth for a given country through time and among different countries, what are the adjustments to be made over nominal GDP? The percentage change in GDP: GDP 2 GDP 1 100, must be price changes over time using CPI GDP 1 (consumer price index) and PPI (producer price index), and purchasing power differences among countries using PPP ( purchasing power parity index). Page 1 of 4

11 ECON01 SMU-Sobey SB-Fall Briefly explain what you know about the differences between economic schools of thought. Slides-1, # 18, article by Krugman (irregular Economics) 7. Briefly explain what you know about the currently prevalent Macroeconomics (RBC (real business cycle). Slides-1, # 18, article by Krugman (irregular Economics) 8. What are the main differences between Keynesian Macro and RBC (real business cycle) Macro? Slides-1, # 18, article by Krugman (irregular Economics) And: IN RBC, money as Nominal (as opposed to Real) variable, is NOT considered as a relevant policy measure and a relevant source of economic fluctuations: money is believed neutral in the long-run. And: In RBC, government is usually not explicitly modeled. And fiscal policy is not considered a relevant measure to remedy structural economic fluctuations: government intervention is judged inefficient/ineffective. 9. What is the main difference between Keynesian Macro and RBC (real business cycle) Macro with respect to monetary policy? In RBC, money as Nominal (as opposed to Real) variable, is NOT considered as a relevant policy measure and a relevant source of economic fluctuations: money is believed neutral in the long-run. 10. What is the main difference between Keynesian Macro and RBC (real business cycle) Macro with respect to fiscal policy (government intervention)? In RBC, government is usually not explicitly modeled. And fiscal policy is not considered a relevant measure to remedy structural economic fluctuations: government intervention is judged inefficient/ineffective. Page 2 of 4

12 ECON01 SMU-Sobey SB-Fall What are the exogenous variables in Solow Growth Model? Technology (production function) Saving rate Depreciation rate Rate of Population Growth 12. In Solow Growth Model, what are the determinants of Steady State (long-run equilibrium) values? Exogenous variables (listed above) 1. In Solow Growth Model, what are the determinants of Steady State (long-run equilibrium) values? 14. In Solow Growth Model, what is the impact of immigration of work-force in the short-run as well as on Steady State (long-run equilibrium) values? Short-run: change in the position of the economy in terms of Y/L (output per capita) and K/L (capital per capita) Long-run (steady-state): None. Add a figure to clarify. 15. In Solow Growth Model, what is the impact of change in saving rate in the short-run as well as on Steady State (long-run equilibrium) values? Short-run: change in the proportion of output that is consumed (less) and saved (more). Long-run (steady-state): higher level of K/L and Y/L (improvement in the standard of living). Add a figure to clarify. 16. In Solow Growth Model, what is the impact of technological progress in the short-run as well as on Steady State (long-run equilibrium) values? Short-run: change in the level of output change in the level of consumption and saving. Long-run (steady-state) suppose technological progress: higher level of K/L and Y/L (improvement in the standard of living). Add a figure to clarify. Page of 4

13 ECON01 SMU-Sobey SB-Fall What can you tell about the shortcomings of Solow Growth Model? Discuss how the exogenous variables are in reality NOT exogenous What are the exogenous variables in our basic General Equilibrium Model? Technology (production function), Propensity to Save/Consume, Population (labour force) 19. What are the endogenous variables in our basic General Equilibrium Model? See notes on Basic Static General Equilibrium 20. In our basic General Equilibrium Model, what is the impact of technological progress? See notes on Basic Static General Equilibrium 21. In our basic General Equilibrium Model, what is the impact of a change in saving rate? See notes on Basic Static General Equilibrium 22. In our basic General Equilibrium Model, what is the impact of a change in population level? See notes on Basic Static General Equilibrium 2. Explain how the Real Wage is determined in our basic General Equilibrium Model. Look at labour market... See notes on Basic Static General Equilibrium 24. Explain how the Real Rental is determined in our basic General Equilibrium Model. Look at rental market... See notes on Basic Static General Equilibrium 25. What is the difference between Partial Equilibrium and General Equilibrium? Partial Eq: one market in isolation, GE: many market interrelated AND in interaction. Good Luck! MD Page 4 of 4

14 Time: 70 Minutes October 25, 2011 Last Name: Student Number: First Name: Major: Midterm ECON01 General Guidelines 1. Write down your identification in the places assigned. 2. Illegible answers will not be read.. Calculator and dictionaries are allowed. 4. This mid-term counts for 25% of your final grade. Mark (/100) Don t write anything in here. Good Luck! Part A. Short Answer Questions (0%). Be brief but complete. 1. How is Economic Growth measured? Comment on the shortcomings of the current methods to measure economic growth. 2. What are the main differences between Keynesian and RBC (real business cycle) Macroeconomics?. In Solow Growth Model, what is the impact of immigration of work-force and increase in saving rate in the short-run as well as on Steady State (long-run equilibrium) values? 4. What is the difference between General Equilibrium and Partial Equilibrium? What are the exogenous and the endogenous variables in a partial equilibrium, Goods Market Model? 5. What can you tell about the relationship between Economic Growth and Income Inequality? What do you know about Canadian situation? Part B. Partial Equilibrium (0%) Labour Market in Yutopia for the workers seeking hourly-wage contracts is characterised by the system of the equations below: P = 120 Q P = 20 + Q (i) Identify demand and supply. (ii) Explain what P and Q signify in this particular market Page 1 of 2

15 Time: 70 Minutes October 25, 2011 (iii) Provide a figure for the market. (iv) Find the equilibrium numerically. (v) Government imposes a $5 tax on the employers hiring hourly-wage contractors in order to encourage the creation of permanent employment. Explain the impact of the tax on supply and demand curves and equilibrium values, compute the new equilibrium values and show it in the old figure. (vi) Yutopia undergoes a boom in information technologies that heavily rely on hourlywage contractors for their labour force. Using a figure, explain the impact of this change on this labour market (use the initial market situation). Part C. General Equilibrium (40%) Disstopia is an agricultural country, functioning based on three markets (Goods, Capital and Labour). The representative agent s real Budget Constraint is expressed below. AF L d, K d W P Ld R P Kd + W P Ls + R P Ks = C + Real Saving Consider our basic Static General Equilibrium Model, and answer the following questions. 1. List the exogenous and endogenous variables. 2. Provide a figure for the representative agent s Budget Constraint.. As a result of climate change, Disstopia s output is significantly reduced. Explain the impact of this change on Disstopia s economy as a whole (all the markets), using appropriate figures. Hint: Think of the negative impact of climate change on productivity as technological progress. the reverse of Good Luck! MD Page 2 of 2

16 ECON 07: Fall 2011, Dr. Maryam Dilmaghani The exams look fine so far, as the exam felt a bit long, I accord % bonus to everyone! Part B: News Article Questions (24%) (1) 1. Use an economic model to illustrate the news (figure). 2. Explain economic factors that are behind your figure. Page 1 of 4

17 Answer The model to use: Asset Market Model. Investors compare Canadian bonds with other financial investment options (other countries bond, especially Eurozone). All else equal, if Euro-zone economies appear to be unlikely to recover and remain economically unsafe again, then demand for Canadian bonds shift rightward (diminishes) and equilibrium price rises. Old demand curve: dash New demand curve: Solid Price Q of Bond Page 2 of 4

18 (2) 1. Use an economic model to illustrate the news (figure). 2. Explain economic factors that are behind your figure. Page of 4

19 Answer If Asset Market Model is used, partial marks will be given. The model to use: Money Market Model. Increasing money supply (monetary expansion) means Money Supply shifts rights wards. Given the Liquidity and Price Level effect, after some time, Money Demand must shift rightwards as well. The nest article suggests that the Price Level effect will be large enough to offset all the positive impact of the monetary expansion policy: and interest rate will be returning to its previous position or above=- monetary policy is ineffective. i M S 1 M d 2 Quantity of Money Page 4 of 4

20 Time: 70 Minutes October 25, 2011 Last Name: Student Number: First Name: Major: Midterm ECON01 General Guidelines 1. Write down your identification in the places assigned. 2. Illegible answers will not be read.. Calculator and dictionaries are allowed. 4. This mid-term counts for 25% of your final grade. Mark (/100) Don t write anything in here. Good Luck! Part A. Short Answer Questions (0%). Be brief but complete. All the answers are in the problem sets. For, Question 5, Kuznets curves (see slides) must be mentioned and the situation of Canada can be explained through the news article handout. 1. How is Economic Growth measured? Comment on the shortcomings of the current methods to measure economic growth. 2. What are the main differences between Keynesian and RBC (real business cycle) Macroeconomics?. In Solow Growth Model, what is the impact of immigration of work-force and increase in saving rate in the short-run as well as on Steady State (long-run equilibrium) values? 4. What is the difference between General Equilibrium and Partial Equilibrium? What are the exogenous and the endogenous variables in a partial equilibrium, Goods Market Model? 5. What can you tell about the relationship between Economic Growth and Income Inequality? What do you know about Canadian situation? Page 1 of

21 Time: 70 Minutes October 25, 2011 Part B. Partial Equilibrium (0%) All the answers are in the problem sets. For, Question (v): it is Supplies shift to the left (Supply: P = QU). For question (vi): As productivity Labour Demand shifts right (the rest, as usual). Labour Market in Yutopia for the workers seeking hourly-wage contracts is characterised by the system of the equations below: P = 120 Q P = 20 + Q (i) Identify demand and supply. (ii) Explain what P and Q signify in this particular market (iii) Provide a figure for the market. (iv) Find the equilibrium numerically. (v) Government imposes a $5 tax on the employers hiring hourly-wage contractors in order to encourage the creation of permanent employment. Explain the impact of the tax on supply and demand curves and equilibrium values, compute the new equilibrium values and show it in the old figure. (vi) Yutopia undergoes a boom in information technologies that heavily rely on hourlywage contractors for their labour force. Using a figure, explain the impact of this change on this labour market (use the initial market situation). Part C. General Equilibrium (40%) Disstopia is an agricultural country, functioning based on three markets (Goods, Capital and Labour). The representative agent s real Budget Constraint is expressed below. AF L d, K d W P Ld R P Kd + W P Ls + R P Ks = C + Real Saving Consider our basic Static General Equilibrium Model, and answer the following questions. 1. List the exogenous and endogenous variables. 2. Provide a figure for the representative agent s Budget Constraint. Page 2 of

22 Time: 70 Minutes October 25, As a result of climate change, Disstopia s output is significantly reduced. Explain the impact of this change on Disstopia s economy as a whole (all the markets), using appropriate figures. Hint: Think of the negative impact of climate change on productivity as technological progress. the reverse of As given in the hint, it is the reverse of technological progress : Productivity of both Labour and Capital input falls as a result of climate change; so using the Answer Key to Technological progress and reversing all the shifts, you get the answer,; it means: (i) For Labour Market: Labour Demand Curve (MPL) shifts to the left W/P (ii) Physical Capital Market: Capital Demand Curve (MPK) shifts to the left R/P Good Luck! MD Page of

23 ECON01 SMU-Sobey SB-Fall 2011 Midterm Preparation: Static General Equilibrium Chapter 6 Dr. Maryam Dilmaghani A Short Note From past lectures, you know that Marginal Product of an input serves of the Demand Curves for that input. A few important points are explained below. Suppose production function is: Y = F(L, K) = AL α K β 1. Marginal Product of Labour (MPL) MPL = AK β (α) L α 1 = AK β (α) L α 1 Hence you see that if the level of stock of capital (K) increase, then MPL shifts because of the term in the square bracket: AK β (α). For instance, for the production function below = AF(K, L) = 6K 1 L 2, we have: MPL = 6 (K) 1 2 L 1 And if K=1000, we get: MPL = 6 (1000) 1 2 L 1 = 40L 1 And if K=1728, we get: MPL = 6 (1728) 1 2 L 1 = 48L 1 Page 1 of 6

24 ECON01 SMU-Sobey SB-Fall 2011 More precisely, you see that increase in the stock of capital increases MPL and leads to a rightward shift of MPL curve. 2. Marginal Product of Capital (MPK) MPK = AL α (β) K β 1 = [AL α (β)] K β 1 Hence you see that if the level of stock of capital (K) increase, then MPL shifts because of the term in the square bracket: [AL α (β)]. For instance, for the production function: Y = AF(K, L) = 6K 1 L 2 we have: MPK = 6 (L) 2 1 K 2 And if L=1000, we get: MPL = 6 (1000) 2 1 K 2 = 200K 2 And if K=2000, we get: MPL = 6 (2000) 1 2 L 1 18L 1 More precisely, you see that increase in the level of labour force increases MPK and leads to a rightward shift of MPK curve. **&** You do not need to memorise the formula for MPL and MPK. In the exam questions, I will give them. Page 2 of 6

25 ECON01 SMU-Sobey SB-Fall 2011 An Exercise The unique output of Terra Nullisa, an Island Kingdom, is produced using Capital and Labour. The level of the stock of capital in Terra Nullisa is 1000 units and the population of workers in Terra Nullisa is The function of the representative agent in Terra Nullisa is expressed below: Y = AF(K, L) = 6K 1 L 2 MPL = AK β (α) L α 1 MPK = [AL α (β)] K β 1 Answer the following questions, provide a figure if necessary. 1. Given the information above, find the equilibrium Real Wage in Terra Nullisa. Compute total Real Income of Workers (suppliers of labour). Equilibrium in labour market is achieved when L d = L s = L W P = MPL We have that in Terra Nullisa L s = 1000 And L d = MPL = 6 (K) 1 2 L 1 = 6 (1000) 1 2 L 1 MPL = 40L 1 Therefore W P = MPL = 40(1000) 1 = = 4 units of output (because it is Real wage). Total income of workers= L s W P = = 4000 Page of 6

26 ECON01 SMU-Sobey SB-Fall Given the information above, find the equilibrium Real Rental Rate in Terra Nullisa. Compute total Real Income of Investors (suppliers of capital). Equilibrium in labour market is achieved when K d = K s = K R P = MPK We have that in Terra Nullisa K s = 1000 And K d = MPK = 6 (L) 2 1 K 2 = 6 (1000) 2 1 K 2 MPK = 200K 2 Therefore R P = MPK = 200(1000) 2 = 200 = 2 units of output (as it is Real rental arte). 100 Total real income of investors= K s R P = = Compute total output in Terra Nullisa. Y = AF(K, L) = 6K 1 L 2 = 6 (1000) 1 (1000) 2 = 6000 You see that: Total output (6000) = Total Labour income (4000) + Total Capital income (2000) **&** Now suppose that through immigration, the number of workers in Terra Nullisa has doubled. Answer the following questions. 1. Find the equilibrium Real Wage in Terra Nullisa after immigration. Compute total real income of Workers (suppliers of labour). Page 4 of 6

27 ECON01 SMU-Sobey SB-Fall 2011 Equilibrium in labour market is achieved when L d = L s = L W P = MPL We have that in Terra Nullisa L s = = 2000 And L d = MPL = 40L 1 Therefore W P = MPL = 40(2000) 1.17 (of units of output because it is Real wage). You see that real wage falls by about 21% : % 4 Total income of workers= L s W P = Given the information above, find the equilibrium Real Rental Rate in Terra Nullisa. Compute total real income of Investors (suppliers of capital). MPK = 6 (L) 2 1 K 2 = 6 (2000) 2 1 K 2 MPK 18K 2 Equilibrium in labour market is achieved when K d = K s = K R P = MPK We have that in Terra Nullisa K s = 1000 And K d = MPK = 18 K 2 Therefore R P = MPK = 18 (1000) 2 18 arte) (of units of output as it is Real rental You see that Real rental rate increase by 90% (almost doubled): = 90% 2 Total income of investors= K s R P = = 180. Compute total output in Terra Nullisa. Y = AF(K, L) = 6K 1 L 2 = 6 (1000) 1 (2000) You see that: Page 5 of 6

28 ECON01 SMU-Sobey SB-Fall 2011 Total output (9524) Total Labour income (640) + Total Capital income (180) 4. Re-explain results of this question in word. Immigration increased labour input in Terra Nullisa. This change impacted Real wage (fall by...), Real rental rate (increase by...) and Total output... It has also impacted the distribution of total income and aggregate output between different groups in Terra Nullisa You observed that immigration equalised total real income of workers and investors of Terra Nullisa. Can you think of reason for it? Page 6 of 6

29 ECON01 SMU-Sobey SB-Fall 2011 Static General Equilibrium, Chapter 6 Note: This file helps understanding for Midterm. However the exercises will NOT be in the midterm examination. A Short Note From past lectures, you know that Marginal Product of an input serves of the Demand Curves for that input. A few important points are explained below. Suppose production function is: Y = F(L, K) = AL α K β 1. Marginal Product of Labour (MPL) MPL = AK β (α) L α 1 = AK β (α) L α 1 Hence you see that if the level of stock of capital (K) increase, then MPL shifts because of the term in the square bracket: AK β (α). For instance, for the production function: (K, L) = 6K 1 L 2, we have: MPL = 6 (K) 1 2 L 1 And if K=1000, we get: MPL = 6 (1000) 1 2 L 1 = 40L 1 And if K=1728, we get: MPL = 6 (1728) 1 2 L 1 = 48L 1 More precisely, you see that increase in the stock of capital increases MPL and leads to a rightward shift of MPL curve. Page 1 of 6

30 ECON01 SMU-Sobey SB-Fall Marginal Product of Capital (MPK) MPK = AL α (β) K β 1 = [AL α (β)] K β 1 Hence you see that if the level of stock of capital (K) increase, then MPL shifts because of the term in the square bracket: [AL α (β)]. For instance, for the production function: Y = AF(K, L) = 6K 1 L 2 we have: MPK = 6 (L) 2 1 K 2 And if L=1000, we get: MPL = 6 (1000) 2 1 K 2 = 200K 2 And if K=2000, we get: MPL = 6 (2000) 1 2 L 1 18L 1 More precisely, you see that increase in the level of labour force increases MPK and leads to a rightward shift of MPK curve. **&** You do not need to memorise the formula for MPL and MPK. In the exam questions, I will give them. Page 2 of 6

31 ECON01 SMU-Sobey SB-Fall 2011 An Exercise The unique output of Terra Nullisa, an Island Kingdom, is produced using Capital and Labour. The level of the stock of capital in Terra Nullisa is 1000 units and the population of workers in Terra Nullisa is The function of the representative agent in Terra Nullisa is expressed below: Y = AF(K, L) = 6L 2 K 1 So: A = 6, α = 2 α 1 = 1, β = 1 β 1 = 2 MPL = AK β (α) L α 1 = 6 2 K1 L 1 MPL = 4K 1 L 1 MPK = [AL α (β)] K β 1 = 6 1 Lα K 2 MPK = 2L 2 K 1 Answer the following questions, provide a figure if necessary. 1. Given the information above, find the equilibrium Real Wage in Terra Nullisa. Compute total Real Income of Workers (suppliers of labour). Equilibrium in labour market is reached when: L d = L s = L W P = MPL calculated at L We know that in Terra Nullisa, labour supply (L s ) is fixed at Therefore we have: L d = L s = L = 1000 Therefore, W P = MPL calculated at L Page of 6

32 ECON01 SMU-Sobey SB-Fall 2011 W P = MPL = 4K 1 L 1 wage). = = 4 units of output (because it is Real Aggregate real income of workers= L W P = = Given the information above, find the equilibrium Real Rental Rate in Terra Nullisa. Compute total Real Income of Investors (suppliers of capital). Equilibrium in capital market is reached when: K d = K s = K R P = MPK calculated at K We know that in Terra Nullisa, supply of capital input (K s ) is d at Therefore we have: K d = K s = K = 1000 And, R P = MPK calculated at K R P = MPK = 2L 2 K 2 wage). = = 2 units of output (because it is Real Aggregate real income of investors= K R P = = Compute total output in Terra Nullisa. Y = AF(K, L) = 6K 1 L 2 = 6 (1000) 1 (1000) 2 = 6000 You see that: Total output (6000) = Total Labour income (4000) + Total Capital income (2000) **&** Now suppose that through immigration, the number of workers in Terra Nullisa has doubled. Answer the following questions. Page 4 of 6

33 ECON01 SMU-Sobey SB-Fall Find the equilibrium Real Wage in Terra Nullisa after immigration. Compute total real income of Workers (suppliers of labour). Equilibrium in labour market is reached when: L d = L s = L W P = MPL calculated at L After immigration, labour supply (L s ) has doubled and is fixed on L = = 2000 Therefore, W P = 4K 1 L 1 calculated at L = You see that equilibrium real wage, W P, falls by about 21%: % 4 Aggregate real income of workers= L W P = = Find the equilibrium Real Rental Rate in Terra Nullisa. Compute total real income of Investors (suppliers of capital). Equilibrium in capital market is reached when: K d = K s = K R P = MPK calculated at K We know that in Terra Nullisa, supply of capital input (K s ) is d at Therefore we have: K d = K s = K = 1000 And, R P = MPK calculated at K R P = MPK = 2L 2 K 2 = units of output You see that equilibrium real rental rate, R P, increases by about 59%: % Aggregate real income of investors= K R P = = Page 5 of 6

34 ECON01 SMU-Sobey SB-Fall Compute total output in Terra Nullisa. Y = AF(K, L) = 6K 1 L 2 = 6 (1000) 1 (2000) You see that: Total output (9525) Total Labour income (640) + Total Capital income (180) = Re-explain results of this question in word. Immigration increased labour input in Terra Nullisa. This change impacted Real wage (fall by...), Real rental rate (increase by...) and Total output... It has also impacted the distribution of total income and aggregate output between different groups in Terra Nullisa You observed that immigration equalised total real income of workers and investors of Terra Nullisa. Can you think of reason for it? Will be explained later... Page 6 of 6

35 ECON01 SMU-Sobey SB-Fall 2011 Final Preparation: Open-Ended Questions -2 Instructor Dr. Maryam Dilmaghani 1. Explain what you know about taxation and fiscal policy in RBC framework. 2. How can you represent the change in the choice of a representative agent in a 2-period model after a change in the interest rate?. Explain the impact of a Positive Transitory Parallel technological shock on the consumers. 4. Explain the impact of a Positive Transitory Parallel technological shock on the producers. 5. What are the two important categories of taxes? How can you implement them in the RBC framework? 6. Explain the impact of an expansionist monetary policy on the both sides of goods market. 7. Explain the impact of an tight monetary policy (contraction) on the both sides of goods market. 8. Is it possible that Real Wage falls as a result of technological progress? 9. Is it possible that Real Rental Rate falls as a result of technological progress? Base your answer on both theory and real world facts. 10. Explain what you know about different kinds of taxes and their impact on GDP. Page 1 of 1

36 ECON01 SMU-Sobey SB-Fall 2011 Final Preparation: Open-Ended Questions -2 Instructor Dr. Maryam Dilmaghani 1. Explain what you know about taxation and fiscal policy in RBC framework. See notes: Lump-sum and proportionate taxes and what fallows How can you represent the change in the choice of a representative agent in a 2-period model after a change in the interest rate? See notes: Budget constraint and IE and SE.... Explain the impact of a Positive Transitory Parallel technological shock on the consumers. The short answer is just to briefly explain that through the change in price It generates Income Effect and Intra-temporal SE (what IE & SE are...) 4. Explain the impact of a Positive Transitory Parallel technological shock on the producers. To increase output and affect output price (with a figure...) 5. What are the two important categories of taxes? How can you implement them in the RBC framework? See above, Question Explain the impact of an expansionist monetary policy on the both sides of goods market: (Goods market would be Long Question). Money See notes To explain increase in Money Supply and fall in Interest rate (with a figure) Explain the impact of an tight monetary policy (contraction) on the both sides of goods market. Page 1 of 2

37 ECON01 SMU-Sobey SB-Fall 2011 See above Is it possible that Real Wage falls as a result of technological progress? Use a Labour Market figure and show normally if shock is parallel then MPL=Labour Demand does not shift so with a capital supply shift (consumers in Good Market) Real Wage can Is it possible that Real Rental Rate falls as a result of technological progress? Base your answer on both theory and real world facts. Use a Capital Market figure and show if the shock is parallel then MPK= Capital demand does not shift so with a capital supply shift (consumers in Good Market) Real rental rate can Explain what you know about different kinds of taxes and their impact on GDP. See notes and explain about distortion... Comment on Macroeconomic Schools /Economics in General (they are also linked to in Facebook Page of the course): And as RBC give the impression of much higher quantitative precision than Keynesians with lots of math and econometrics. accuracy of Economic Models in General, through reading like (they are also linked to in Facebook Page of the course): y.pdf Good luck! MD Page 2 of 2

38 ECON01: Fall 2011 SMU-Sobey SB Name: Student ID: Quiz Look the figures below and answer the questions. Figure1 Figure2 Figure Output Output Output Labour Labour Labour 1. What is the difference between the figures 1 & 2? 2. What is the difference between the figures 1 &?. Which figure is the most plausible to stand as production function? Why? Page 1 of 1

39 ECON01: SMU Fall 2011 Last Name/ First Name/ Student ID: Intermediate Macroeconomics Quiz 2 Dr. Maryam Dilmaghani Given the article, 1. What can you tell about the relationship between technological progress and economic growth? (5 lines) 2. What can you tell about the relationship between technological progress and economic development? (5 lines) Page 1 of 1

40 ECON01.1 : Fall 2011 SMU-Sobey SB Name: Student ID: Quiz 1 Reading the text Irregular Economics by Paul Krugman, answer the following questions. 1. What is your impression about the main message of the author (at this point, you may not be able to tell for sure, but have a guess)? 2. What is the main question this text brings to your mind?. List the terms and the expressions that you think relate to this course. Page 1 of 1

41 ECON07: Fall 2011 November 17 th, 2011 Beginning of Lecture Last Name/ First Name/ Student ID: Intermediate Macroeconomics: Assignment 2-Part 1 Instructor: Dr. Maryam Dilmagani Part A The unique output of Terra Nullisa, an Island Kingdom, is produced using Capital and Labour. The level of the stock of capital in Terra Nullisa is 1000 units and the population of workers in Terra Nullisa is The function of the representative agent in Terra Nullisa is expressed below: Y = AF(K, L) = L 2 K 1 So: A = 1, α = 2 1 α 1 =, β = 1 β 1 = 2 MPL = AK β (α) L α 1 = 2 K1 L 1 MPL = 2 K1 L 1 MPK = [AL α (β)] K β 1 = 1 Lα K 2 MPK = 1 L2 K 1 Answer the following questions, provide a figure if necessary. 1. Given the information above, find the equilibrium Real Wage in Terra Nullisa. Compute total Real Income of Workers (suppliers of labour). Equilibrium Real Wage, W P = MPL calculated at L As the labour supply is fixed at 1000 workers, we have: MPL = 2 K1 L 1 = (1000) 1 = units of output Page 1 of 11

42 ECON07: Fall 2011 November 17 th, 2011 Beginning of Lecture Total Real Income of Workers= Real Wage Labour Supply= = Given the information above, find the equilibrium Real Rental Rate in Terra Nullisa. Compute total Real Income of Investors (suppliers of capital). Equilibrium Real Rental rate, R P = MPK calculated at K As Capital supply is fixed at 1000 units, we have: MPK = 1 L2 K 2 = (1000) 2 = 1 0. units of output Total Real Income of Investors= Real Rental Rate Capital Supply= = Compute total output in Terra Nullisa. Y = AF(K, L) = L 2 K 1 = (1000) 2 (1000) 1 = = 1000 units **&** Now suppose that through emigration, the number of workers in Terra Nullisa reduced to half. Answer the following questions. 1. Find the equilibrium Real Wage in Terra Nullisa after immigration. Compute total real income of Workers (suppliers of labour). Equilibrium Real Wage, W P = MPL calculated at L As the labour supply is now fixed at 1000 = 500 workers, so we have: MPL = 2 K1 L 1 = (500) 1 2 Page 2 of 11 = units of output 8 We see that real wage, it makes sense as there is a labor shortage after emigration. Total Real Income of Workers= Real Wage Labour Supply= = 840

43 ECON07: Fall 2011 November 17 th, 2011 Beginning of Lecture 2. Find the equilibrium Real Rental Rate in Terra Nullisa. Compute total real income of Investors (suppliers of capital). Equilibrium Real Rental rate, R P = MPK calculated at K As Capital supply is fixed at 1000 units, we have: MPK = 1 L2 K 2 Total Real Income = (1000) 2 = units of output 00 of Investors= Real Rental Rate Capital Supply= = 10 We see that real rental rate, it makes sense as the marginal productivity of physical capital is a function of the level of labor input: L MPK Total Real Income of Investors= Real Rental Rate Capital Supply= = 210 units. Compute total output in Terra Nullisa. Y = AF(K, L) = L 2 K 1 = (500) 2 (1000) 1 = 6 10 = 60 units 4. Re-explain results of this question in word. Labour force emigrated from Terra Nullisa to other places hence the available workforce fell leading to labor shortage and increase in real wage. It also caused the productivity (marginal product) of physical capital to fall, lack of workers to exploit it hence the real return to such investment (real rental rate) fell as well. Clearly, it also led to a fall in total output. Page of 11

44 ECON07: Fall 2011 November 17 th, 2011 Beginning of Lecture Part B As a result of a number of factors, climatic conditions in Terra Nullisa change such that the Island s productivity in its unique output (an agricultural product) increases greatly. However, the experts believe that the change is not permanent and will be reverted in a few years. Question Use the Multi-period Dynamic General Equilibrium to explain the impact of this change in Labour Market in Terra Nullisa (Real wage and the level of employment). Hint: It is a Proportionate and Transitory Technological Progress in Terra Nullisa. If the outcome depends on the relative magnitudes of the changes (e.g. IE and SE), examine all possible cases. Proportionate and Permanent Technological Progress. Recall that a proportionate shift of production function is characterised by an upward shift of production function is in below: Total output, Y = AF(K, L) New output Y New = (A ε) F(K, L) with ε> 1 Y/L K/L And Marginal Products (MPL & MPK) shifts rightward. Page 4 of 11

45 ECON07: Fall 2011 November 17 th, 2011 Beginning of Lecture Step 1: Goods Market (i) Supply-side (i)-1: Technological Progress Output All else equal, Price (P) (i)-2: MPL & MPK L d shift right & K d shifts rightward. The shifts in MPL and MPK are forever (because the technological change is permanent). (ii) Demand-side As P W P it generates both Income and Substitution Effect. (ii)-1: Income Effect (IE) is positive The agent can have more of both consumption and leisure, forever. It means C t (S t ) and Z t (L t )for all t, by IE. Note that the t subscript indicates the period of time. (ii)-2: Intra-temporal Substitution Effect (Intra-SE) W P The opportunity cost of leisure C tis now cheaper relative to Z t C t (S t ) and Z t (L t ) in every given period, by Intra-SE. (ii)-: Inter-temporal Substitution Effect (Inter-SE): As output only increases temporarily: Z 1 (L 1 ) As output only increases temporarily P 1 < P 2, P C 1 (S 1 ) **&*** Hence, Total Effect on Labour supply depends on the relative magnitude of IE (L t ) and Inter & Intra-SE (L t ) Since the increase in output is temporary, the income effect must be small so L s Page 5 of 11

46 ECON07: Fall 2011 November 17 th, 2011 Beginning of Lecture And, Total Effect on Capital supply is all towards a fall K s Step 2: Labour Market Now, we just need to put supply and demand together and see what happens to the equilibrium real wage, W P, and equilibrium level of employment, L. Old curves: Dash New Curves: Solid As we see that both W P and L. It means that Real Wage increases and the level of employment rises. W/P Labour Step : Capital Market Now, we just need to put supply and demand together and see what happens to the equilibrium real wage, R P, and equilibrium level of employment, K. Old curves: Dash Page 6 of 11

47 ECON07: Fall 2011 November 17 th, 2011 Beginning of Lecture New Curves: Solid As we see that both R P and K? it is ambigous: it depends on the magnitude of the shifts. It is reasonable to assume that the Demand shift is larger hence it may slightly increase. R/P Capital Part C As a result of progress in biotechnology, Terra Nullisa partially switches to genetically engineered crops. As a result, the Island s productivity in its unique output (an agricultural product) increases greatly. Answer the following questions. Questions (i) Use the Multi-period Dynamic General Equilibrium to explain the impact of this change on Labour & Capital Markets in Terra Nullisa. Page 7 of 11

48 ECON07: Fall 2011 November 17 th, 2011 Beginning of Lecture Hint: It is a Proportionate and Permanent Technological Progress in Terra Nullisa. If the outcome depends on the relative magnitudes of the changes (e.g. IE and SE), examine all possible cases. Proportionate and Permanent Technological Progress: Recall that a proportionate shift of production function is characterized by an upward shift of production function is in below: Total output, Y = AF(K, L) New output Y New = (A ε) F(K, L) with ε> 1 Y/L K/L And Marginal Products (MPL & MPK) shift rightward. Step 1: Goods Market (i) Supply-side (i)-1: Technological Progress Output All else equal, Price (P) (i)-2: MPK K d shifts rightward. The shift MPK is forever (because the technological change is permanent). (ii) Demand-side Page 8 of 11

49 ECON07: Fall 2011 November 17 th, 2011 Beginning of Lecture As P R P it generates both Income and Substitution Effect. (ii)-1: Income Effect (IE) is positive The agent can have more of both consumption and leisure, forever. It means C t and S t by IE. Also: and Z t (L t )for all t ( t). Note that t mean for all periods of time (forever). (ii)-2: Intra-temporal Substitution Effect (Intra-SE) Recall: The trade-off involved with Intra-SE is to compare the sources of utility (satisfaction) in each period with each other, i.e. C 1 with Z 1, C 2 with Z 2, taking into account their (opportunity) cost. P W P The opportunity cost of leisure C tis now cheaper relative to Z t C t and S t by Intra SE. (Also: Z t (L t ) in every given period, by Intra-SE; but here we ignore labour market). (ii)-: Inter-temporal Substitution Effect (Inter-SE) does NOT exist. As the change is permanent, all the periods in future are identical, hence it does not make sense to have different patterns (a permanent change, as a rule, does not generate Inter-temporal Substitution Effect). Hence, Total Effect on Capital Supply is negative, meaning a shift to the left. Step 2: Labour Market Now, we just need to put supply and demand together and see what happens to the equilibrium real wage, W P, and equilibrium level of employment, L. Old curves: Dash New Curves: Solid Page 9 of 11

50 ECON07: Fall 2011 November 17 th, 2011 Beginning of Lecture The magnitude of shifts are assumed (they can be larger or smaller). As we see that both W P and L. It means that Real Wage increases and the level of employment rises. W/P Labour Step : Capital Market Now, we just need to put supply and demand together and see what happens to the equilibrium real rental rate, W P, and equilibrium level of physical capital, K. Old curves: Dash New Curves: Solid The magnitude of shifts are assumed (they can be larger or smaller). As we see that both R P and K. It means that Real Rental Rate increases and the level of physical capital investment rises as well. Page 10 of 11

51 ECON07: Fall 2011 November 17 th, 2011 Beginning of Lecture R/P Capital (ii) Noticing the possible negative health and environmental impact of the genetically modified crops, the government of Terra Nullisa imposed a tax on the producers. What is the impact of this tax on the economy as a whole (all the markets)? Hint: Tax on producers makes supply curve shifting to the left and price in Goods Market increase. It is just to counteract the fall in price and do the same analysis. Taxes on workers and investors will be discussed in class. Page 11 of 11

52 ECON01 SMU-Sobey SB-Fall 2011 Problem Set 1 Topic 1: GDP and Economics Growth Read the news article below and answer the following questions. 1. What can you tell about an economic growth rate of.%? 2. What can you tell about the fact that seemingly the rise in the annual growth rate has been caused by a rise in the exports?. Explain why the news of a rise in the rate of growth of GDP above the expected rate may lead to an increase of interest rate by Bank of Canada. 4. Explain how the increase in interest rate in implemented by Bank of Canada. Page 1 of 1

53 ECON01 SMU-Sobey SB- Fall 2011 Intermediate Macroeconomics Problem Set 2: GDP and Economics Growth Read the news article below and answer the following questions. 1. What can you tell about an economic growth rate of.%? Recalling the long-run average growth rate of Canadian GDP,.% rate is a magnitude higher than the average (about 2%). Growth theories suggest that there is a sustainable path for the growth of a country s GDP that depends on the level of the stock of capitals in the country (physical capital, human capital and natural capital). An increase in the rate of growth may be unsustainable if it exceeds the rate the correspond to the installed stock of capital. Page 1 of 4