Problem/practice set 5
The graphs on the right illustrate the IS-LM-PC model with a given real interest rate (LM) and Phillip's curve (PC). If this economy is currently experiencing a negative output gap, what do you know about the location of the IS curve? a. Which of the following events could have caused the negative output gap that you indicated on the graph?
A. A decrease in government spending. D. An increase in tax rates
The graph on the right shows f(Kt/N) and sf (Kt/N) for an economy. Suppose the steady state for this economy occurs where capital per worker = 5 Given this information, show where the line representing depreciation must lie. Also indicate the level of investment per worker and output per worker that occurs at the steady state.
Based on where you placed points A and B on the graph, what do we know about the saving rate in this economy? The saving rate is 0.6 (2.4/4)
In order to write the production function in the form below, according to the textbook, what two key assumptions must we make? Yt/N=f(Kt/N)
Employment is constant and there is no technological progress in the economy.
A higher saving rate implies a higher level of capital per effective worker in the steady state and thus a higher rate of growth of output per effective worker.
False
If (u − un) is greater than zero, then (Y − Yn) is greater than zero.
False
If (u − un) is less than zero, the output gap is negative.
False
In a medium-run equilibrium, the rate of inflation is stable at zero
False
In steady state, output per effective worker grows at the rate of population growth.
False
Okun's law says that if output growth increases by one percentage point, the rate of unemployment drops by one percentage point.
False
Technology has not played an important part in Chinese economic growth.
False
The IS curve shifts right with an increase in G, right with an increase in T, and right with an increase in x.
False
The central bank can always act to keep output equal to potential output.
False
The fact that one cannot patent a theorem implies that private firms will not engage in basic research.
False
In order to write the relationship between investment and output in the form below, what key assumptions must we make? It=sYt
We assume that public saving, T − G, is equal to zero and that private saving, S, is proportional to income.
A permanent increase in government spending would require a higher real policy rate be put in place by the central bank in order to anchor expected inflation.
True
Active policy changes, either in monetary policy or fiscal policy, are required to return the economy to full medium-run equilibrium if a shock is permanent.
True
At the natural rate of unemployment, inflation is at the anchored rate of expected inflation
True
Even if the potential returns from R&D spending are identical to the potential returns from investing in a new machine, R&D spending is much riskier for firms than investing in new machines.
True
If (u − un) is equal to zero, the output is at potential.
True
If the output gap is positive, inflation is higher than anchored rate of expected inflation.
True
If the rate of technological progress increases, the investment rate (the ratio of investment to output) must increase to keep capital per effective worker constant.
True
In steady state, output per worker grows at the rate of technological progress.
True
Writing the production function in terms of capital and effective labor implies that as the level of technology increases by 10%, the number of workers required to achieve the same level of output decreases by 10%.
True
Suppose, due to the effects of a military conflict that has ended, that a country experiences a large reduction in its capital stock. Assume no other effects of this event on the economy. Which of the following will tend to occur as the economy adjusts to this situation?
a relative high growth rate for some time.
a. Even if the potential returns from R&D spending are identical to the potential returns from investing in a new machine, R&D spending is much riskier for firms than investing in new machines because b. Which of the following is not a reason for firms to engage in basic research:
a. all of the above. b. firms cannot patent a theorem.
When steady state capital per worker is above the golden−rule level, we know with certainty that an increase in the saving rate will
decrease consumption in both the short run and the long run.
As fiscal consolidation takes place, the central bank should
decrease the policy rate
In the absence of technological progress, an increase in the saving rate will cause which of the following?
increase temporarily the growth of output per worker.
Suppose two countries are identical in every way with the following exception. Economy A has a higher rate of depreciation (δ) than economy B. Given this information, we know with certainty that:
steady state consumption in A is lower than in B
Based on our understanding of the model presented in the chapter, which of the following will cause a permanent increase in growth? A. an increase in education spending B. an increase in capital accumulation C. an increase in the saving rate D. all of the above
none of the above
As an economy adjusts to an increase in the saving rate, we would expect output per worker: A.to decrease at a permanently higher rate. B.to increase at a permanently higher rate. C.to return to its original level. D.to increase at a constant rate and continue increasing at that rate in the steady state.
none of the above.
Which of the following are reasons to suspect spending on education might overestimate human capital investment?
part of total spending on education is really consumption.
The dot-com revolution began during the late 1990s, when technological progress related to personal computers took central stage in the U.S. economy. Huge investments were made in the technology industry and the economy went through a period rapid growth and eventually the dot-com bubble was formed. This technological progress caused many of the workers, who could not update their skills, to lose their jobs. In 2000-2001 when the dot-com bubble burst, many skilled workers in the industry found themselves to be unemployed as well.
Given this example, it can be concluded that the workers who lost their jobs prior to the dot-com bubble burst would have experienced a smaller percentage decrease in their relative incomes, as compared to the relative incomes of the workers who lost their jobs after the burst. Also, workers who were laid off prior to the burst experienced a faster recovery in wages, as compared to the workers laid off after the burst.
This chapter outlines the impact of shocks on the economy in the short run and in the medium run. Your stance on what policies should be implemented may depend on your view of whether there should be a short-run or medium-run focus.
If you believe the economy adjusts slowly to shocks, you will likely have a more short-run focus and would advocate for policies that impact output quickly.
During and following the financial crisis and recession of 2008-2010, several European countries proposed austerity measures that would help shrink the size of the national deficits within the countries. These proposed measures included tax hikes and cuts in government spending. When this happened in the United States in the 1990s, there was an accompanying decrease in the policy rate to help avoid slowing the economy down too much. Why was this same policy decision more difficult in Europe?
In response to the recession, the policy rate in Europe had already been lowered close to the zero lower bound, so additional decreases were not viable.
There are many unanswered questions regarding the effects of robots on the future of society, but there are some things most economists would agree on. Which of the following is something most economists would likely agree on?
Policymakers will face many difficult challenges concerning property rights and the distribution of wealth.
A large increase in the price of oil increases the natural rate of unemployment.
Uncertain
Because eventually we will know everything, growth will have to come to an end.
Uncertain
When would a higher saving rate increase consumption in the steady state?
When the saving rate is below the golden-rule level, a higher saving rate raises the level of steady-state consumption.
In a developed capitalist economy, many companies have replaced factory workers with robots. The country is investing heavily in a robotic workforce to improve efficiency and reduce cost, leading to a mass-layoff. There are good educational institutions in this economy, and education is subsidized up to the high school diploma level. The government encourages investment in research and development, technological innovation and its manufacturing. There are no specific regulations for the working hours and wages paid. a. Which of the following will not be an effect of this scenario for the long-term? b. Which of the following factors will further increase the demand gap between high-skilled and low-skilled workers?
a. A reduction in social mobility. b. Outsourcing low-skilled work to low-wage countries
Suppose the production function takes the following form: YN = f (K/N, H/N), where Y/N is output per worker, K/N is physical capital per worker, and H/N is human capital per worker. a. of the following is true regarding the production function above? b. Would you expect investment aimed at increasing education to have a larger impact in a developing nation or in a rich nation?
a. All of the above are true. b. Developing nation, since it is starting at a lower level of education and not subject to the same level of decreasing returns as a rich nation.
a. Which of the following is a reason why transforming Social Security from a pay-as-you-go system to a fully funded system could raise consumption in the future? A.It is likely the U.S. saving rate is below the golden-rule level. B.Transforming Social Security would ultimately increase the U.S. saving rate. C.From the golden-rule discussion, if the saving rate is below the golden rule, increases in saving will lead to higher steady-state consumption levels. b. If the U.S. capital stock is below the golden-rule level, should the government give tax breaks for saving?
a. All of the above. b. No, because the increase in future consumption will come at the cost of current consumption.
a. Which of the following is a reason why transforming Social Security from a pay-as-you-go system to a fully funded system could raise consumption in the future? b. If the U.S. capital stock is below the golden-rule level, should the government give tax breaks for saving?
a. All of the above. b. No, because the increase in future consumption will come at the cost of current consumption.
a. graph on the right shows an IS-LM graph for an economy. Point C on the graph represents the economy at potential output, Yn, with the natural rate of interest, rn. Assume that expected inflation is equal to last year's inflation. b. In order to move the economy from point A1 to point B1, what policy prescription would the central bank need to follow?
a. If the economy started at point C and moved to point A1, the best way to describe the economy is that it is now recessionary and there is downward pressure on inflation. b. The central bank must decrease the policy rate. When the economy reaches point B1, inflation will still be decreasing If the central bank is eventually successful in returning the economy to point C, the level of inflation will be lower than it was when the economy was originally at point C.
Fiscal consolidation at the Zero Lower Bound. Suppose the economy is operating at the zero lower bound for the nominal policy rate; the initial equilibrium is at the positive target rate of inflation and the economy is resting at potential output but there is a large government deficit in period t. A newly elected government vows to cut spending and permanently reduces the deficit by cutting G and raising T in period t + 1 and subsequent periods. The government policy to reduce the deficit has caused output from period t to period t + 1 to fall and the deviation of inflation from target over this period has become negative a. Suppose with inflation persistently less than the target rate of inflation, the expected rate of inflation falls. When would inflation become negative in this situation?
a. Inflation would become negative if income is greatly lower than potential.
Okun's Law is written as u− u(−1) = −0.4 (gy − 3%). What is the sign of u − u(−1) in a recovery? During a recovery, unemployment is falling, making the sign of u − u(−1) negative. a. In the equation for Okun's Law written above, where does the 3% number come from? b. Why is the coefficient on the term (gy − 3%) equal to −0.4 and not −1? (Check all that apply.) c. Suppose the number of immigrants per year allowed to enter the United States is sharply decreased. How would Okun's Law change?
a. It is the sum of the labor-force growth rate and the labor-productivity growth rate in the United States. b. A. Training new employees is costly so firms hoard workers during recessions. B. An increase in the employment rate does not lead to a one-for-one decrease in the unemployment rate. c. If the number of immigrants sharply decreased, there would be a fall in potential output, causing the number 3 in the equation to become smaller.
Suppose there is an increase in consumer confidence in period +1. How does this impact the IS-LM graph? refer to the graph. a. Assume that the central bank does not change the real policy rate. How will the short-run equilibrium in period t+1 compare to the equilibrium in period t? b. Consider the period t+2 equilibrium under the assumption that πet+2 = πt+1. If the central bank leaves the real policy rate unchanged, how does actual inflation in period t+2 compare to inflation in period t+1? c. What do you conclude about the central bank policy of keeping the real policy rate unchanged in period t+2? Is it sustainable?
a. Output will be above potential and inflation will be above expected inflation. b. To keep the real policy rate unchanged, the central bank would need to increase the nominal policy rate. Actual inflation in period +2 will be greater than inflation in period t+1. c. Output will increase above the natural rate. Inflation will remain above 2% and the target rate of inflation will eventually fall apart.
The price of oil in the United States has been very volatile over the last 50 years, with the real price of oil showing a few dramatic swings. Recently, during the pandemic there were initially large reductions in the real price of oil, followed later by large increases in the real price of oil associated with the Russian invasion of Ukraine, and the resulting US and EU oil embargoes. a. When did these swings occur, and what can explain them? b. Should there be any concern in the United States about political and economic stability in OPEC nations?
a. The first dramatic swing happened in the 1970s when there was a sharp rise in the real price of oil caused by the formation of OPEC. The second swing happened in the 2000s when there was a sharp rise in the real price of oil caused by increased demand from emerging economies. In 2008 when there was a sharp drop in the real price of oil caused by a large financial crisis. A change in the price of oil enters the model for this chapter as a change in input costs, which directly shifts the price-setting relation since it is viewed as a markup of the price over nominal wages. b. Yes, instability could lead to large increases in the price of oil, which could lead to stagflation in the United States.
Assume there is a permanent reduction in the rate of technological progress. a. What is the likely impact on the growth rate and the level of output per worker in the short run and in the long run? Assume there is a permanent reduction in the saving rate. b. What is the likely impact on the growth rate and the level of output per worker in the short run and in the long run?
a. The growth rate of output per worker falls in the short run. In the long run, the growth rate approaches a new steady state with a permanently lower growth rate. Output per worker continues to rise over time, just at a slower rate. b. There is no effect on the steady-state growth rate of output per worker. The growth rate of output per worker falls in the short run, but in the long run it approaches its original steady-state rate.
Suppose the production function is given by: Y = sqrtK sqrtN, where Y is output, K is capital, and N is the number of workers. What is the impact on output if both the level of capital and the number of workers double? a. If the levels of both capital and labor double, the production function becomes: Y = sqrt2K sqrt2N, b. Which of the following is true regarding the functional form of the production function shown above?
a. This results in output increasing by exactly double, meaning in this case, there are constant returns to scale b. It exhibits decreasing returns to both capital and labor.
This problem is based on the material in the chapter appendix. Suppose that the economy's production function is given by Y=KαN1−α where Y is output, K is capital, and N is labor. Assume that α = 1/3. a. This production function is characterized by b. Decreasing returns occur for the variables
a. constant returns to scale, because doubling inputs will double output. b. capital and labor.
a. This problem is based on the material in the chapter appendix. Suppose that the economy's production function is given by Y=KαN1−α where Y is output, K is capital, and N is labor. Assume that α = 1/3. This production function is characterized by __________. b. Decreasing returns occur for the variables
a. constant returns to scale, because doubling inputs will double output. b. capital and labor.
a. Writing the production function in terms of capital and effective labor implies that as the level of technology increases by 10%, the number of workers required to achieve the same level of output b. If the rate of technological progress increases, in order to keep capital per effective worker constant, the
a. decreases by 10%. b. investment rate must increase.
Using the model presented in this chapter and assuming that the economy begins in the steady state, what is the effect of an increase in the saving rate on output per worker likely to be after one decade? a. The level of output will be _________ it was in the initial steady state. The growth rate of output per worker will be __________ it was in its initial steady state. Using the model presented in this chapter and assuming that the economy begins in the steady state, what is the effect of an increase in the saving rate on output per worker likely to be after five decades? b. The level of output will be __________ it was in the initial steady state. The growth rate of output per worker will be __________ it was in its initial steady state.
a. higher than; higher than b. higher than; similar to what
a. A country's openness to trade can affect output per worker through __________ because it can impact the diffusion of technology. b. Low tax rates and good public infrastructure would be expected to raise output per worker because c. Low population growth would be expected to
a. productivity b. all of the above c. raise output per worker, because it will raise all of the levels of inputs and productivity per worker.
A new innovation is implemented in the two countries, which can bring down the time taken during the production process by 50%. It needs a combination of highly skilled labor to manage the new technology, and a large number of workers, who are not necessarily highly skilled, to actually work on the site. Given these initial conditions, select all the correct statements from the below options:
a. the demand for skilled labor will increase in both of the countries b. In the long-run, the demand and supply gap for skilled labor will reduce drastically in Country Y, but not in Country X. c. There will be an increase in income inequality in both the countries. f. The demand for unskilled or lesser skilled labor will increase in Country Y. g. There will be mass layoffs carried out by the firms in Country X
a. If saving is equal to __________. b. If capital never depreciated, growth could go on forever because _________.
a. the sum of public saving plus private saving, then saving is equal to investment. b. capital per worker could only increase and make workers more productive.
How might the following policy changes affect the wage gap between low-skill and high-skill workers in the United States? Increased spending on computers in public schools. a. This should __________ the wage gap between low-skill and high-skill workers in the United States, since it is likely to __________ the relative __________ high-skill workers. Restrictions on the number of foreign temporary agricultural workers allowed to enter the United States. b. This should __________ the wage gap between low-skill and high-skill workers in the United States, since it is likely to __________ the relative __________ low-skill workers.
a. reduce; increase; supply of b. reduce; reduce; supply of
b. If expected inflation changed to a negative value, then in period t + 2, the real policy rate will _________. This will cause output in period t + 3 to _________. c. How does the zero lower bound on nominal interest rates make a fiscal consolidation more difficult?
b. increase; fall further c. When facing a zero lower bound, fiscal consolidation can lead to decreasing output and deflation, which will lower tax revenue, making it harder to reduce the deficit.
The medium-run equilibrium is characterized by four conditions: 1. Output is equal to potential output Y = Yn and the real policy rate r Subscript rn must be chosen by the central bank so: 2. The unemployment rate is equal to the natural rate u = un. 3. The real policy interest rate is equal to the natural rate of interest r Subscript rn where rn is defined as the policy rate where Yn = C(Yn−T) + I (Yn, rn+x) + G. 4. The expected and actual rate of inflation πe is equal to the anchored or target rate of inflation, bar π. This implies the nominal policy rate i=rn+bar π. Which of the following best characterizes the behavior of inflation in a medium-run equilibrium if the level of expected inflation is formed so πe equals bar π?
bar π.
d. Now consider the period t+2 equilibrium making the assumption that πet+2 = π. If the central bank leaves the real policy rate unchanged, how does actual inflation in period t+2 compare to inflation in period t+1? e. Explain why the policy choice to maintain the real policy rate at the original level in period t+2 is not a sustainable policy? f. How did the inflation outcomes differ when expected inflation was anchored (πet+2 = π) relative to when it was lagged (πet+2 = πt+1)? Under anchored expectations, there was _________, and under lagged expectations, there was _________. g. Which scenario —that inflation is anchored or that inflation is based on the previous year's rate —do you think is more realistic under a positive output gap?
d. To keep the real policy rate unchanged, the central bank would need to not change the nominal policy rate. Actual inflation in period t+2 will be equal to inflation in period t+1. e. When actual inflation continually exceeds the target and expected rates of inflation, eventually expected inflation will become un-anchored. f. a permanently higher level of inflation; an acceleration of inflation g. Neither are likely, as the central bank will not likely accept ever increasing inflation nor will it permanently use an incorrect anchor for inflation.
The wage setting relation is
downward sloping.
h. Suppose in period t+4, the central bank decides to raise the real policy rate high enough to return the economy immediately to potential output and to the period t rate of inflation. Explain the difference between central bank policies using the two assumptions about expected inflation.
h. Under anchored inflation expectations, the central bank would have to raise the policy rate enough to eliminate the output gap. This higher rate will cause inflation to return to the anchored rate. Once the inflation goal has been achieved, the central bank will not need to make any further changes. Under lagged inflation expectations, the central bank would have to raise the policy rate significantly higher than if expectations were anchored. This significantly higher rate will cause a recession, causing large reductions in inflation. Once the inflation goal has been achieved, the central bank can return the policy rate to its original level.
From 1970 to the mid−1990s, the relative price of crude petroleum
increased dramatically, then decreased dramatically.
the Phillips curve shows that when the unemployment rate is lower than the natural rate,
inflation is higher than expected.
Suppose the following situation exists for an economy: Kt+1/N = Kt/N. Given this information, we know with certainty that:
investment per worker equals depreciation per worker in period t
Okun's law shows that when the unemployment rate is below the natural rate,
output is above potential.
Which of the following is NOT a flow variable?
the money supply.
A higher saving rate implies a higher level of capital per effective worker in the steady state and
the rate of growth of output per effective worker remains unchanged.
