Macro Exam 2 Review

Some economic historians have noted that during the period of the gold standard, gold discoveries were most likely to occur after a long deflation. What might explain this observation?

After a long period of deflation, an ounce of gold would buy more goods and services. This created a greater incentive to look for new gold deposits.

a. During the Great Recession, the unemployment rate rose from 5% in December 2007 to 9.5% in June 2009. b. A narrower measure of underutilization that includes only those unemployed for 15 weeks or longer rose from 1.6% in December 2007 to 5.1% in June 2009. c. A broader measure of underutilization that includes marginally attached workers and those employed part-time for economic reasons rose from 8.8% in December 2007 to 16.4% in June 2009. d. The various measures of labor underutilization have different levels but move together.

Fred Graph

Suppose that Congress passes legislation making it more difficult for firms to fire workers. One example might be a law requiring severance pay for fired workers. The goal of this legislation is to reduce the rate of job separation without affecting the rate of job finding. Use this information to answer the following three questions. (Assume the size of the labor force remains constant.)

If this legislation reduces the rate of job separation (s) without affecting the rate of job finding (f), how would the natural rate of unemployment change? a. The natural rate of unemployment will decrease. b. The rate of job separation will decrease, and the average spell of employment will increase. c. For any given decrease in s, making it more costly for firms to fire an employee may also make it more costly for firms to hire an employee. This would decrease f and, if the reduction in f is large enough, increase U/L.

Consider Swan Island, an economy described by the Solow model. There is no population growth or technological progress. The production function is 𝑦=20𝑘13y=20k13. The initial capital stock per worker is 125. According to the national income accounts, investment equals 18 percent of national income, and depreciation equals 12.5 percent of national income. Calculate the following:

National income: y=100 Consumption: c=82 Savings rate: s=0.18 Depreciation: sk=12.5 Depreciation rate: s=0.1 Change in capital stock in the next period: K=5.5 Steady state capital stock: k*=216 Steady-state income: y*=120

During World War II, both Germany and England had plans for a paper weapon. They each printed the other's currency, with the intention of dropping large quantities by airplane, thereby increasing each other's money supply.

Select all of the following reasons that might have made this an effective weapon. - Relative prices would become more variable. - Hyperinflation could undermine the public's confidence in the economy. - Menu and shoe leather costs would rise.

A newspaper article once reported that the U.S. economy was experiencing a low rate of inflation. It said that "low inflation has a downside: 45 million recipients of Social Security and other benefits will see their checks go up by just 2.8% next year."

a. Policymakers link increases in Social Security and other benefits to inflation because they wish to ensure that the real value of these benefits is constant over time. b. Is the small increase in benefits a "downside" of low inflation, as the article suggested? No, as long as inflation is measured correctly, Social Security beneficiaries' purchasing power will not change.

a. Moving from the smallest to the largest value over this time span, what is the percentage change in the money supply M (M2)? b. Moving from the smallest to the largest value over this time span, what is the percentage change in the velocity of money (as measured using M2)? c. Moving from the smallest to the largest value over this time span, what is the percentage change in the price level P (as measured by the GDP deflator)? d. Moving from the smallest to the largest value over this time span, what is the percentage change in output (as measured by real GDP)? e. Based on your previous answers, which of the four variables in the quantity equation is the most stable in the sense of showing the smallest percentage variation over time?

a. 860.4% b. 59.2% c. 177.9% d. 187.9% e. V

Productivity increases have pushed real wages higher in both Europe and the United States over the last few decades. Blanchard's hypothesis uses geographic differences in cultural preferences to explain why hours of labor per worker in the United States differ from those in Europe. Apply the income and substitution effect concepts to Blanchard's hypothesis and answer the questions below.

a. As real wages have increased over the last four decades, hours of labor per worker have remained constant in the United States and fallen in Europe. b. These data suggest that the income effect is dominant in most workers' preferences in Europe. c. These data also suggest that the income effect is roughly equal to the substitution effect in most workers' preferences in the United States.

Select the cost of inflation that best describes each scenario.

a. Because inflation has risen, a clothing company decides to issue a new catalog monthly instead of quarterly. Menu costs. b. Grandma buys an annuity for $100,000 from an insurance company, which promises to pay $10,000 a year for the rest of her life. After buying it, she is surprised that high inflation triples the price level over the next few years. Cost of unexpected inflation. c. Maria lives in an economy with hyperinflation. Each day after being paid, she runs to the store as quickly as possible so she can spend her money before it loses value. Shoeleather costs d. Gita lives in an economy with an inflation rate of 10%. Over the past year, she earned a return of $50,000 on her million-dollar portfolio of stocks and bonds. Because her tax rate is 20%, she paid $10,000 to the government. Altered tax liability. e.Your father tells you that when he was your age, he worked for only $4 an hour. He suggests that you are lucky to have a job that pays $9 an hour. Inconvenience of a changing price level.

A friend and fellow student shares her employment experience over the last 12-week summer break. It took her one full week to find a job. She started on the first day of week two and was able to keep her job for the remaining eleven weeks. Use this information to answer the following three questions, assuming the unemployment rate is not changing:

a. Calculate the rate of job finding (f) for the summer, using an average rate per week. Enter this value in the box below. Note that if f is the rate of job finding, then the average spell of unemployment is (1/f). The value of f is 12. b. Calculate the rate of job separation (s), using an average rate per week. Enter this value into the box below. Note that if s is the rate of job separation, then the average length of employment is (1/s). The value of s is 1.09. c. Calculate the natural rate of unemployment (U) using the above results and enter this value in the box below. The natural rate of unemployment is 8.33%.

Consider how unemployment would affect the Solow model. Suppose that output is produced according to the production function 𝑌=𝐾𝛼[(1−𝑢)𝐿]1−𝛼Y=Kα[(1−u)L]1−α, where K is capital, L is the labor force, and 𝑢u is the natural rate of unemployment. The national saving is rate 𝑠s, the labor force grows at rate 𝑛n, and capital depreciates at rate 𝛿δ.

a. Express output per worker (𝑦=𝑌𝐿y=YL) as a function of capital per worker (𝑘=𝐾𝐿k=KL) and the natural rate of unemployment (𝑢u). [y=k^a x (1-u)^1-a] c. What is the relationship between 𝑢 and output? negative e. How does this change affect output immediately? Over time? Immediately, output increases because of the increase in labor in the production function; over time, the capital stock expands to accommodate additional workers, and output increases further.

Owners of office buildings seek firms to lease their available space, just like prospective employees seek firms to hire their labor. The rate of office separation would be the fraction of occupied office space that is vacated each month. The rate of office finding would be the fraction of vacant office space that is leased each month. Let u be the "natural rate of office vacancy." Use these concepts to answer the following questions.

a. If s is the rate of office separation, then 1/s is the average spell of office occupancy. b. If f is the rate of office finding, then 1/f is the average spell of office vacancy. c. The natural rate of office vacancy (u) will increase when s increases.

The government of Lilliput relies on substantial seigniorage to finance its spending, while the government of Blefuscu does not rely on seigniorage at all. Otherwise, the two nations are similar.

a. Lilliput has a higher rate of money growth. b. According to the quantity theory the rate of inflation will be higher in Lilliput. c. According to the Fisher effect the nominal interest rate will be higher in Lilliput. d. Residents of Lilliput hold lower real money balances and experience higher shoe leather costs.

Suppose the steady-state capital stock is initially below the Golden Rule level. Use the Solow growth model to assess the following claim: "Devoting a larger share of national output to investment would help restore rapid productivity growth and rising living standards."

a. Productivity growth will initially rise and return to its initial level as the economy achieves a new steady state. b. Living standards will initially fall and rise to a higher level as the economy achieves a new steady state.

The steady-state rate of unemployment is 𝑈𝐿=𝑠𝑠+𝑓UL=ss+f. Suppose that the unemployment rate does not begin at this level. Use this relationship to show that unemployment will evolve over time and reach this steady state.

a. The change in the number of people who become unemployed (ΔUt+1) is the difference between the number of employed people losing their current jobs and the number of unemployed people finding new jobs. The number of employed people losing their jobs can be expessed as [s x Et, or sEt] b. The number of unemployed people finding new jobs can be expressed as [fx Ut, or fUt] c. The change in the number of unemployed is therefore ΔUt+1 = [sEt - fUt] d. The labor force (L) is the sum of people who are employed (Et) and unemployed (Ut), L = Et + Ut. (We assume that L is constant.) Substituting for Et in the expression you identified in part c yields ΔUt+1 = [s(L-Ut)-fUt] e. To obtain an expression for the change in the unemployment rate, divide both sides of the equation you derived in part d by L and rearrange the terms on the right-hand side to show that (ΔUt+1L) =[s-(s+f)Ut/L] h. The equation you derived in part g implies that whenever the actual unemployment rate is less than the natural rate, the unemployment rate will rise over time

In the discussion of German and Japanese postwar growth, the text describes what happens when part of the capital stock is destroyed in a war. By contrast, suppose that a war does not directly affect the capital stock but that casualties reduce the labor force. Assume that the economy was in a steady state before the war, that the saving rate is unchanged, and that the rate of population growth is the same as before the war.

a. What is the immediate impact on total output? It decreases. b. What is the immediate impact on output per person? It increases. c. What happens subsequently to output per person in the postwar economy? It declines. d. What happens to the growth rate of output per worker after the war but before the economy reaches a new steady state? It is less than zero.

The economy of Macro Island is described by the quantity equation with constant velocity. All residents of Macro Island understand the quantity theory and use it to form their expectations of inflation. Real income grows at a steady 2 percent per year, and the nominal interest rate is 5 percent. In one year, people had expected the money supply to grow by 4 percent, but in fact it grew by only 3 percent.

a. What was the inflation rate? 1% b. What was the expected inflation rate? 2% c. What was the ex ante real interest rate? 3% d. What was the ex post real interest rate? 4% e. Did the deviation of inflation from what was expected hurt creditors or debtors?

Suppose a country has a money demand function (𝑀𝑃)𝑑=𝑘𝑌(MP)d=kY, where k is a constant parameter. The money supply grows by 12 percent per year, and real income grows by 4 percent per year.

a. what is the average inflation rate? 8& b. If real income growth were higher, inflation would be lower. c. What is the relationship between the parameter k and the velocity of money? 𝑉=1𝑘V=1k: k is inversely related to velocity, i.e., the more money people hold for a given real income, the smaller velocity is, and vice versa. d. Suppose that instead of a constant money demand function, the velocity of money in this economy was growing steadily due to financial innovation. Assuming everything else was unchanged, how would that affect the inflation rate? The inflation rate would increase.

Consider these two labor market scenarios. The scenario with the labor union results in the same real wage as before the shock, but the level of unemployment has

risen