EC202 Macroeconomics

Transcription

1 EC202 Macroeconomics Koç University, Summer 2014 by Arhan Ertan Study Questions Assume that in a small open economy where full employment always prevails, national saving is 300. a. If domestic investment is given by I = r, where r is the real interest rate in percent, what would the equilibrium interest rate be if the economy were closed? b. If the economy is open and the world interest rate is 10 percent, what will investment be? c. What will the current account surplus or deficit be? What will net capital outflow be? 2. Assume that in a small open economy with full employment, consumption depends only on disposable income. National saving is 300, investment is given by I = r, where r is the real interest rate in percent, and the world interest rate is 10 percent. a. If government spending rises by 100, does investment change? What is the level of investment after the change? b. Does the trade balance change if G rises by 100? If it changes, does it increase or decrease, and by how much? c. Does net capital outflow change if G rises by 100? If it changes, does it increase or decrease, and by how much? d. Will the real exchange rate rise, fall, or remain constant as a result of the change in G? 3. The government of a small open economy wishes to promote trade policies that will result in currency appreciation. a. Would protectionist policies (higher tariffs and more quotas) or freer trade policies (tariff reductions and quota eliminations) be more effective in generating currency appreciation? b. Illustrate graphically the impact of the trade policy on the exchange rate of the small open economy. c. What will happen to the trade balance of the small open economy as a result of the trade policies, assuming that the country started from a position of free trade? d. What will happen to the quantity of exports and imports as a result of the trade policies? Page 1

2 4. Compare the impact of an increase in the government's budget deficit on investment spending in a small open economy with an otherwise comparable closed economy. Assume prices are flexible and that factors of production are fully employed in both economies. Assume there is perfect capital mobility for the small open economy. 5. Explain why government budget deficits crowd out private investment spending in a closed economy, but crowd out net exports in a small open economy. Assume prices are flexible and that factors of production are fully employed in both economies. Assume there is perfect capital mobility for the small open economy. 6. What determines the real exchange rate and what determines the nominal exchange rate in a small open economy with perfect capital mobility, fully employed factors of production, and flexible prices? 7. The real interest rates and real exchanges rates are constant and equal in North Country and South Country. The Fisher equation and purchasing-power parity hold in both countries. If the nominal interest rate is 8 percent in North Country and 10 percent in South Country, do you expect North Country's nominal exchange rate to appreciate, depreciate, or remain the same? Explain. 8. In times of great economic uncertainty and potential job loss, many consumers may increase their saving as a precautionary measure. What is the predicted impact of an increase in national saving on the domestic interest rate and exchange rate in a large open economy, holding other factors constant. Illustrate your answer graphically and explain in words. 9. If the rate of job separation is 0.02 per month and the rate of job finding is 0.10 per month, what is the natural rate of unemployment? 10. Changes in economic policies will frequently have an impact on the unemployment rate. Explain whether each of the policy changes described is likely to: (1) affect frictional or structural unemployment and (2) increase or decrease the measured unemployment rate. a. The government reduces the number of weeks of unemployment insurance that unemployed workers can receive. b. The government raises the minimum wage. c. The government increases spending on job-training programs. Page 2

3 11. Assume that the real wage in an economy is held above equilibrium. a. Graphically illustrate how an increase in technology that raises the demand for labor will change the number of unemployed workers. Be sure to label the axes and the quantities of labor hired before and after the technological progress. b. Explain in words what happens to the number of unemployed as a result of this change. 12. Explain what type of wage rigidity is most likely to affect the unemployment rates of the following types of workers: a. workers with low marginal labor productivity, b. workers in the construction trades, such as plumbers and electricians, c. workers engaged in creative work that is not easily monitored. 13. Explain how technological changes that have reduced the demand for low-skilled workers can change the natural rate of unemployment. 14. Assume that a country's production function is Y = K 1/2 L 1/2. a. What is the per-worker production function y = f(k)? b. Assume that the country possesses 40,000 units of capital and 10,000 units of labor. What is Y? What is labor productivity computed from the per-worker production function? Is this value the same as labor productivity computed from the original production function? c. Assume that 10 percent of capital depreciates each year. What gross saving rate is necessary to make the given capital labor ratio the steady-state capital labor ratio? (Hint: In a steady state with no population growth or technological change, the saving rate multiplied by per-worker output must equal the depreciation rate multiplied by the capital labor ratio.) d. If the saving rate equals the steady-state level, what is consumption per worker? 15. Suppose that two countries are exactly alike in every respect except that the citizens of country A have a higher saving rate than the citizens of country B. a. Which country will have the higher level of output per worker in the steady state? Illustrate graphically. b. Which country will have the faster rate of growth of output per worker in the steady state? 16. It rains so much in the country of Tropicana that capital equipment rusts out (depreciates) at a much faster rate than it does in the country of Sahara. If the countries are otherwise identical, in which country will the Golden Rule level of capital per worker be higher? Illustrate graphically. Page 3

4 17. The economy of Alpha can be described by the Solow growth model. The following are some characteristics of the Alpha economy: saving rate (s) 0.20 depreciation rate ( ) 0.12 steady-state capital per worker (k) 4 population growth rate (n) 0.02 steady-state output per worker 20,000 a. What is the steady-state growth rate of output per worker in Alpha? b. What is the steady-state growth rate of total output in Alpha? c. What is the level of steady-state consumption per worker in Alpha? d. What is the steady-state level of investment per worker in Alpha? 18. Compare and contrast the impact of a faster rate of population growth on the standard of living (output per worker) in the models by Solow, Malthus, and Kremer. 19. The economies of two countries, Thrifty and Profligate, have the same production functions and depreciation rates. There is no population growth or technological progress in either country. The economies of each country can be described by the Solow growth model. The saving rate in Thrifty is 0.3. The saving rate in Profligate is a. In which country is the level of steady-state output per worker larger? Explain. b. In which country is the steady-state growth rate of output per worker larger? c. In which country is the growth rate of steady-state total output greater? Page 4

5 Answer Key 1. a. 5 percent b. 200 c. The trade surplus will be a. No. 200 b. Yes. It decreases by 100. c. Yes. It decreases by 100. d. It will rise. 3. a. Protectionist policies will result in currency appreciation. b. The protectionist policies increase the demand for net exports. The trade balance will remain unchanged still balanced. c. d. The volume of exports will decrease (as a result of the currency appreciation), and the volume of imports will decrease (as a result of the protectionist policies and currency appreciation). 4. Investment spending decreases in the closed economy, but does not change in the small open economy. In the closed economy the increase in the budget deficit reduces national saving and increases the interest rate, which decreases private investment spending. In the small open economy the domestic interest rate remains unchanged at the world interest rate. Although national saving also declines in the small open economy, capital inflows make up this shortfall in domestic saving to finance domestic investment. 5. In the closed economy, the increase in the budget deficit reduces national saving and increases the interest rate, which crowds out (decreases) private investment spending. In the small open economy, the budget deficit reduces national saving, which increases the real exchange rate. The increase in the real exchange rate crowds out (decreases) net exports. Page 5

6 6. The real exchange rate adjusts to bring the net exports and net capital outflows into equilibrium. The nominal exchange rate equals the real exchange rate times the ratio of the foreign price level to the domestic price level. 7. From the Fisher equation, inflation is expected to be higher in South Country than in North Country, since the nominal interest rate equals the real interest rate plus the expected rate of inflation and the real interest rate is the same in both countries while the nominal interest rate is higher in South Country. According to purchasing-power parity, the change in the North Country's nominal exchange rate equals the change in the real exchange rate (which is constant) plus the difference in inflation rates (foreign inflation minus domestic inflation). Since South Country's expected inflation is higher, then North Country's nominal exchange rate should appreciate, i.e., each unit of North Country's currency should exchange for more units of South Country currency in the future. 8. The increase in national saving will decrease the domestic interest rate. The lower interest rate will increase the amount of net capital outflows, which will decrease the domestic exchange rate as the supply of the domestic currency in the foreign exchange market increases. Page 6

7 percent 10. a. Frictional unemployment is likely to be reduced as unemployed workers take fewer weeks to search for new jobs because of reduced benefits. This process is likely to reduce the measured unemployment rate. b. Structural unemployment will probably increase for those workers with marginal product valued below the higher minimum wage. This policy change is likely to increase the measured unemployment rate. c. Frictional unemployment will be reduced if workers with obsolete skills receive training that prepares them for available jobs. This policy change is intended to reduce the measured rate of unemployment. 11. a. b. The number of unemployed falls from (L L 1 ) to (L L 2 ). 12. a. minimum wage b. union wage c. efficiency wage 13. The reduction in the demand for low-skilled workers will reduce the equilibrium real wage. The greater disparity between a rigid wage (the result of a minimum wage, union wage, or efficiency wage) and the equilibrium wage, the greater the excess supply of labor and the higher the unemployment rate. 14. a. y = k 1/2. b. Y = 20,000; Y/L = 2; y = 2; yes c. s = 0.2. d. Consumption per worker will be 1.6. Page 7

8 15. a. Country A will have the higher level of output per worker. b. In the steady state the growth rate of output per worker will be zero in both country A and country B. 16. The Golden Rule level of capital per worker will be higher in Sahara. 17. a. In the steady state, capital per worker is constant, so output per worker is constant. Thus, the growth rate of steady-state output per worker is 0. b. In the steady state, population grows at 2 percent rate (0.02). Capital must grow at a rate of 2 percent in order to maintain a constant capital per worker ratio in the steady state; therefore, given the constant returns to scale production function, total output must increase at a 2 percent rate. c. If the saving rate is 20 percent, then the consumption rate is 80 percent (1 0.2). Steady-state consumption per worker is 16,000, which is 80 percent of steady-state output per worker. d. In the steady state, investment per worker equals saving per worker, which is 20 percent of steady-state output per worker. Thus, steady-state investment per worker is 4,000. Page 8

9 18. In the Solow growth model a faster rate of population growth reduces output per worker because capital must be spread more thinly over the supply of workers. In Malthus's model faster population growth exhausts the supply of food and leads to a lower standard of living. In Kremer's model faster rates of population growth increase the pool from which new ideas and innovations can be drawn and thereby improves the standard of living. 19. a. Thrifty will have the higher level of steady-state output per worker. With a higher saving rate in Thrifty, there will be more saving, more investment, and, consequently, a higher steady-state capital per worker ratio. For the same production function, the higher capital per worker ratio will produce a higher level of steady-state output per worker. b. In the steady state in both countries, capital per worker is constant, so output per worker is constant. The growth rate of output per worker is zero in both Thrifty and Profligate. c. Since there is no population growth or technological change in the steady state, total output will be constant in both countries. The growth rate of total output will be zero in both Thrifty and Profligate. Page 9