FINAL EXAM: Macro Winter 2017

Transcription

1 Name: FINAL EXAM: Macro Winter 217 State clearly your assumptions when you derive a result. You must always show your thinking to get full credit. You have 2.5 hours. Good luck! 1

2 Please leave this page blank for your grade. 2

3 Question 1 In the tiny island of Papaya Republic they once again need your help. You have been called to act as a consultant to the government. The economy of Papaya Republic produces and consumes papayas and laptop computers only. In the following table you can find data for two different years: Year 2 Year 27 Price of a laptop $5, $6, Price of a papaya $1 $2 Number of laptops produced 1 12 Number of papayas produced 5, 4, a) Using the Year 2 as the base year, compute the following statistics for each year: Nominal GDP; Real GDP; Real GDP growth rate; the price deflator for GDP; and a fixed-weight price index like the CPI assuming that the typical Papayan consumer buys 125 papayas and.5 laptops every month. (5 pts.) b) How much have prices risen in Papaya Republic between year 2 and year 27? What was the inflation rate? (3 pts.) 3

4 c) The Prime Minister is not happy with the figures on inflation you came up with. He asks you to compute them in some other way. Check how your results change if the base year now becomes 27. (4 pts.) d) The Central Statistical office of Papaya had forgot to add data for 23 to their tables (see below). Compute CPI and GDP deflator for the period 2-3 and 23-7, maintaining 2 as the base year. Does it matter if you use the CPI or the GDP deflator in computing inflation rates over these two periods? (4 pts.) Year 2 Year 23 Year 27 Price of a laptop $5, $5,4 $6, Price of a papaya $1 $15 $2 Number of laptops produced Number of papayas produced 5, 6, 4, 4

5 Question 2 The Papayan Central Bank has a fuzzy understanding of why it should really care about inflation. What are the real costs of inflation? Please remind them of the problems associated with inflation when: a) Inflation is expected. (4 pts.) b) Inflation is unexpected. (4 pts.) 5

6 Question 3 Consider the economy of the Papaya Republic. 1. The consumption function is given by C = (Y - T) 2. The investment function is I = 2 25r 3. Government purchases and taxes are both 1 a) For this economy graph the IS curve for r ranging from to 8. (3 pts.) b) The money demand function in Papaya is (M d /P) = Y 1r and the money supply is M s = 1 and the price level is 2. For this economy graph the LM curve for r ranging from to 8. (3 pts.) c) Find the equilibrium interest rate r and the equilibrium level of income Y. (4 pts.) 6

7 d) Suppose government purchases are up from 1 to 15. How much does the IS curve shift? (4 pts.) e) What are the new equilibrium interest rate and level of income? (4 pts.) f) Suppose instead that money supply is raised from 1 to 12. How much does the LM shift? What are the new equilibrium interest rate and level of income? (4 pts.) 7

8 g) Derive and graph an equation for the aggregate demand curve. (5 pts.) h) What happens to this AD curve if fiscal or monetary policy changes, as in parts (d) and (f)? (5 pts.) 8

9 Question 4 Suppose the government wants to raise investment but keep output constant. In the IS-LM model, what mix of monetary and fiscal policy will achieve this goal? In the early 198 s, the US government cut taxes and run a budget deficit while the Fed pursued a tight monetary policy. What effect should this policy mix have? (5 pts.) Question 5 One of the smartest economists in the Papaya Republic comes to you and tells you: I think I can prove that changes in consumption are unpredictable if consumers obey the permanent income hypothesis and have rational expectations. Show that you can match her intuition explaining why that is true (8 pts.) 9

10 Question 6 Fantastic news in the Papaya Republic the minister of finances tells you over the phone We have discovered a large oil reservoir that s going to be available for centuries to come and enough to supply oil at minimal cost for our national production. Describe him graphically how the short run, labor market and the long run equilibrium will change in response to the news. Assume that workers in Papaya experience very low income effects. You may use the graphs below. 1

11 Short run here (1 pts.) LRAS SRAS Ns P W/P AD ND Y N NOTES LRAS LM r IS Y 11

12 Labor market here. (1 pts.) LRAS SRAS Ns P W/P AD ND Y N NOTES LRAS LM r IS Y 12

13 Long run here (1 pts.) LRAS SRAS Ns P W/P AD ND Y N NOTES LRAS LM r IS Y 13

14 Question 7 The Fed is considering two alternative monetary policies: 1) holding the money supply constant and letting the interest rate adjust; 2) adjusting the money supply and hold the interest rate constant. In the IS-LM model which policy would be better at stabilizing output under the following conditions? Explain. i) All shocks in the economy arise from exogenous changes in the demand for goods and services. (5 pts.) ii) All shocks in the economy arise from exogenous changes in the demand for money. (5 pts.) 14

15 Question 8 Consider the effects of inflation on a graduated-rate income tax. In 1985, before the tax simplification of 1986, the individual income tax system in the United States had many different tax-rate brackets. A married couple paid individual income tax on labor income in accordance with the following table: Range of Taxable Income Marginal Income Tax Rate 3,54-5,719 5,72-7,919 7,92-12,389 12,39-16,649 16,65-21,19 21,2-25,599 25,6-31,119 31,12-36,629 36,63-47,669 47,67-62,449 62,45-89,89 89,9-113, ,86-169, ,2- a) Compute average and marginal tax rates of a couple earning $13, in total. (4 pts.) b) Suppose that each person s real income remains constant over time, so that inflation steadily raises each person s nominal income. If the tax schedule shown in the table had remained unchanged, what would have happened over time to each couple s marginal tax rate? (4 pts.) 15

16 c) What are the likely effects of this on labor supply according your analysis of point b). Suppose there are no income effects. (4 pts.) d) Suppose now that the dollar bracket limits shown in the first row of the table are adjusted proportionately (or indexed ) over time for changes in the real price level. That is, if the price level rises by 5%, each dollar amount raises by 5%. What, then, is the effect of inflation on each couple s marginal income tax rate? (This indexing provision applies in the United States since 1985.) (4 pts.) 16

17 e) What are the likely effects of this on labor supply according your analysis of point d). Suppose there are no income effects. (4 pts.) 17