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Macroeconomics Principles And Policy 12th International Edition William J. Baumol, Alan S. Blinder - Solutions

3. You are given the following information about an economy:C = 0.90DI I = 100 G = 540(X – IM) = –40 T = 1 3Ya. Find equilibrium GDP and the budget deficit.b. Suppose the government, unhappy with the budget deficit, decides to cut government spending by precisely the amount of the deficit you
2. This question is a variant of the previous problem that approaches things in the way that a fiscal policy planner might. In an economy whose consumption function and tax function are as given in Test Yourself Question 1, with investment fixed at 320 and net exports fixed at –80, find the value
1. Consider an economy described by the following set of equations:C = 120 + 0.80DI I = 320 G = 480(X – IM) = –80 T = 200 + 0.25Y Find the equilibrium level of GDP. Next, find the multipliers for government purchases and for fixed taxes.If full employment comes at Y = 1,800, what are some
2. Discuss the pros and cons of having a higher or lower multiplier.
1. When the income-tax rate declines, as it did in the United States in the early 2000s, does the multiplier go up or down? Explain why.
3. (More difficult) Suppose real GDP is $10,000 billion and the basic expenditure multiplier is two. If two tax changes are made at the same time:a. fixed taxes are raised by $100 billion,b. the income-tax rate is reduced from 20 percent to 18 percent, will equilibrium GDP on the demand side rise
2. In a certain economy, the multiplier for government purchases is 2 and the multiplier for changes in fixed taxes is 1.5. The government then proposes to raise both spending and taxes by $100 billion. What should happen to equilibrium GDP on the demand side?
1. Explain the logic behind the finding that variable imports reduce the numerical value of the multiplier.
3. Now raise exports to $650 and find the equilibrium again. How large is the multiplier?
1. Explain the logic behind the finding that variable imports reduce the numerical value of the multiplier.shown in the following table, construct a 45° line diagram and locate the equilibrium level of GDP.GDP Domestic Expenditures$2,500 $3,100 3,000 3,400 3,500 3,700 4,000 4,000 4,500 4,300 5,000
2. If domestic expenditure (the sum of C + I + G in the economy described in Test Yourself Question 1) is as
1. Suppose exports and imports of a country are given by the following:GDP Exports Imports$2,500 $400 $250 3,000 400 300 3,500 400 350 4,000 400 400 4,500 400 450 5,000 400 500 Calculate net exports at each level of GDP.
2. (More difficult) What would happen to the multiplier analysis if b = 0? If b = 1?
1. Explain the basic logic behind the multiplier in words.Why does it requireb, the marginal propensity to consume, to be between 0 and 1?
5. Fredonia has the following consumption function:C = 100 + 0.8DI Firms in Fredonia always invest $700 and net exports are zero, initially. The government budget is balanced with spending and taxes both equal to $500.a. Find the equilibrium level of GDP.b. How much is saved? Is saving equal to
4. Imagine an economy in which consumer expenditure is represented by the following equation:C = 50 + 0.75DI Imagine also that investors want to spend $500 at every level of income (I = $500), net exports are zero (X – IM = 0), government purchases are $300, and taxes are $200.a. What is the
3. In each of these cases, how much saving is there in equilibrium?(Hint: Income not consumed must be saved.) Is saving equal to investment?
2. Referring to Test Yourself Question 1, do the same for an economy in which investment is $250, net exports are zero, government purchases and taxes are both $400, and the consumption function is as follows:C = 250 + 0.5DI
1. Find the equilibrium level of GDP demanded in an economy in which investment is always $300, net exports are always –$50, the government budget is balanced with purchases and taxes both equal to $400, and the consumption function is described by the following algebraic equation:C = 150 +
3. Explain why national income and gross domestic product would be essentially equal if there were no depreciation.
2. Explain the difference between government spending and government purchases of goods and services (G).Which is larger?
1. Explain the difference between final goods and intermediate goods. Why is it sometimes difficult to apply this distinction in practice? In this regard, why is the concept of value added useful?
3. (More difficult) Now complicate Trivialand in the following ways and answer the same questions. In addition, calculate national income and disposable income.3a. The government bought 50 cars, leaving only 150 cars for export. In addition, the government spent$800,000 on wages and made $1,200,000
2. The following outline provides a complete description of all economic activity in Trivialand for 2010. Draw up versions of Tables 3 and 4 for Trivialand showing GDP computed in two different ways.2 i. There are thousands of farmers but only two big business firms in Trivialand: Specific Motors
1. Which of the following transactions are included in the gross domestic product, and by how much does each raise GDP?a. You buy a new Toyota, made in the United States, paying $25,000.b. You buy a new Toyota, imported from Japan, paying$25,000.c. You buy a used Cadillac, paying $12,000.d. Google
6. The example in the appendix showed that the Student Price Index (SPI) rose by 42 percent from 1983 to 2009.You can understand the meaning of this better if you do the following:a. Use Table 5 to compute the fraction of total spending accounted for by each of the three items in 1983. Call these
5. Average hourly earnings in the U.S. economy during several past years were as follows:1970 1980 1990 2000 2010$3.40 $6.85 $10.20 $14.02 $19.07 Use the CPI numbers provided on the inside back cover of this book to calculate the real wage (in 1982–1984 dollars) for each of these years. Which
4. Use the following data to compute the College Price Index for 2009 using the base 1982 = 100.Item Price in 1982 Quantity per Month in 1982 Price in 2009 Button-down shirts $10 1 $25 Loafers 25 1 55 Sneakers 10 3 35 Textbooks 12 12 40 Jeans 12 3 30 Restaurant meals 5 11 14
3. Fill in the blanks in the following table of GDP statistics:2007 2008 2009 Nominal GDP 14,062 14,119 Real GDP 13,229 13,229 GDP deflator 108.6 109.6(No, that’s not a misprint. Real GDP was exactly the same in 2007 and 2008.)
2. Below you will find nominal GDP and the GDP deflator(based on 2005 = 100) for the years 1989, 1999, and 2009.a. Compute real GDP for each year.b. Compute the percentage change in nominal and real GDP from 1989 to 1999, and from 1999 to 2009.c. Compute the percentage change in the GDP deflator
1. Below you will find the yearly average values of the Dow Jones Industrial Average, the most popular index of stock market prices, for five different years. The Consumer Price Index for each year (on a base of 1982–1984 = 100) can be found on the inside back cover of this book. Use these
5. In Figure 8, interpret the economic meaning of points A and B. What do the two points have in common? What is the difference in their economic interpretation?
4. In Figure 6, determine the values of X and Y at point K and at point E. What do you conclude about the slopes of the lines on which K and E are located?
3. Colin believes that the number of job offers he will get depends on the number of courses in which his grade is B+ or better. He concludes from observation that the following figures are typical:Number of grades of B+ or better 0 1 2 3 4 Number of job offers 1 3 4 5 6 Put these numbers into a
2. From Figure 5, calculate the slope of the curve at point M.
1. Portray the following hypothetical data on a twovariable diagram:Academic Year Total Enrollment Enrollment in Economics Courses 2004–2005 3,000 300 2005–2006 3,100 325 2006–2007 3,200 350 2007–2008 3,300 375 2008–2009 3,400 400 Measure the slope of the resulting line, and explain what
7. In 2010 and 2011, the international value of the dollar fell. This development was viewed with alarm in Japan.Why?
6. In 2001, 2002, and 2003, Congress passed the series of tax cuts that President Bush had requested. What effect did this policy likely have on the U.S. trade deficit? Why?
5. Given what you now know, do you think it was a good idea for the United States to adopt a policy mix of tight money and large government budget deficits in the early 1980s? Why or why not? What were the benefits and costs of reversing that policy mix in the 1990s?
4. Explain why American fiscal policy is less powerful and American monetary policy is more powerful than indicated in the closed-economy model described earlier in this book.
3. Explain why a currency depreciation leads to an improvement in a country’s trade balance.
2. If inflation is lower in Germany than in Spain (as it is), and the exchange rate between the two countries is fixed(as it is, because of the monetary union), what is likely to happen to the balance of trade between the two countries?
1. For years, the U.S. government has been trying to get Japan and the European Union to expand their economies faster. Explain how more rapid growth in Japan would affect the U.S. economy.
3. (More difficult) Suppose consumption and investment are described by the following:C = 150 + 0.75DI I = 300 + 0.2Y – 50r Here DI is disposable income, Y is GDP, and r, the interest rate, is measured in percentage points. (For example, a 5 percent interest rate is r = 5.) Exports and imports
2. Explain why X – IM = (S – I) – (G – T). Now multiply both sides of this equation by –1 to get IM – X = (I – S) + (G – T)and remember that the trade deficit, IM – X, is the amount we have to borrow from foreigners to get Borrowing from foreigners = (I – S) + (G – T)Explain
1. Use an aggregate supply-demand diagram to analyze the effects of a currency appreciation.
8. In 2011, market forces raised the international value of the Japanese yen. Why do you think the government of Japan was unhappy about this currency appreciation?(Hint: Japan was trying to recover from both a recession and a disastrous earthquake/tsunami at the time.) If they wanted to stop the
7. Suppose you want to reserve a hotel room in London for the coming summer but are worried that the value of the pound may rise between now and then, making the room too expensive for your budget. Explain how a speculator could relieve you of this worry. (Don’t actually try it—speculators deal
6. Explain why the members of the Bretton Woods conference in 1944 wanted to establish a system of fixed exchange rates. What flaw led to the ultimate breakdown of the system in 1971?
5. Under the old gold standard, what do you think happened to world prices when a huge gold strike occurred in California in 1849? What do you think happened when the world went without any important new gold strikes for 20 years or so?
4. How are the problems of a country faced with a balance of payments deficit similar to those posed by a government regulation that holds the price of milk above the equilibrium level? (Hint: Think of each in terms of a supply-demand diagram.)
3. During the first half of the 1980s, inflation in (West)Germany was consistently lower than that in the United States. What, then, does the purchasing-power parity theory predict should have happened to the exchange rate between the mark and the dollar between 1980 and 1985? (Look at Table 1 to
2. If the dollar appreciates relative to the euro, will the German camera you have wanted become more or less expensive? What effect do you imagine this change will have on American demand for German cameras? Does the American demand curve for euros, therefore, slope upward or downward? Explain.
1. What items do you own or routinely consume that are produced abroad? From what countries do these items come? Suppose Americans decided to buy fewer of these things. How would that affect the exchange rates between the dollar and these currencies?
4. We learned in this chapter that successful speculators buy a currency when demand is weak and sell it when demand is strong. Use supply and demand diagrams for two different periods (one with weak demand, the other with strong demand) to show why this activity will limit price fluctuations.
3. Suppose each of the transactions listed in Test Yourself Question 2 was done by many Americans. Indicate how each would affect the international value of the dollar if exchange rates were floating.
2. For each of the following transactions, indicate how it would affect the U.S. balance of payments if exchange rates were fixed:a. You spent the summer traveling in Europe.b. Your uncle in Canada sent you $20 as a birthday present.c. You bought a new Honda, made in Japan.d. You bought a new
1. Use supply and demand diagrams to analyze the effect of the following actions on the exchange rate between the dollar and the yen:a. Japan opens its domestic markets to more foreign competition.b. Investors come to believe that values on the Tokyo stock market will fall.c. The Federal Reserve
7. Suppose the United States finds Country X guilty of unfair trade practices and penalizes it with import quotas.So U.S. imports from Country X fall. Suppose, further, that Country X does not alter its trade practices in any way. Is the United States better or worse off? What about Country X?
6. Under current trade law, the president of the United States must report periodically to Congress on countries engaging in unfair trade practices that inhibit U.S.exports. How would you define an “unfair” trade practice? Suppose Country X exports much more to the United States than it
5. Country A has a mercantilist government that believes it is always best to export more than it imports. As a consequence, it exports more to Country B every year than it imports from Country B. After 100 years of this arrangement, both countries are destroyed in an earthquake.What were the
4. After the removal of a quota on sugar, many U.S. sugar farms go bankrupt. Discuss the pros and cons of removing the quota in the short and long runs.
3. Country A has a cold climate with a short growing season, but a highly skilled labor force (think of Finland).What sorts of products do you think it is likely to produce?What are the characteristics of the countries with which you would expect it to trade?346 Part 4 The United States in the
2. In the eighteenth century, some writers argued that one person in a trade could be made better off only by gaining at the expense of the other. Explain the fallacy in this argument.
1. You have a dozen shirts and your roommate has six pairs of shoes worth roughly the same amount of money.You decide to swap six shirts for three pairs of shoes. In financial terms, neither of you gains anything. Explain why you are nevertheless both likely to be better off.
2. Suppose that the United States and Mexico are the only two countries in the world and that labor is the only productive input. In the United States, a worker can produce 12 bushels of wheat or 2 barrels of oil in a day.In Mexico, a worker can produce 2 bushels of wheat or 4 barrels of oil per
1. The following table describes the number of yards of cloth and barrels of wine that can be produced with a week’s worth of labor in England and Portugal. Assume that no other inputs are needed.In England In Portugal Cloth 8 yards 12 yards Wine 2 barrels 6 barrelsa. If there is no trade, what
8. The year 2007 closed with the unemployment rate around 5 percent, real GDP barely growing, inflation above 2 percent and apparently rising a bit, and the federal budget showing a large deficit.a. Give one or more arguments for engaging in expansionary monetary or fiscal policies under these
7. It is often said that the Federal Reserve Board typically cares more about inflation and less about unemployment than the administration. If this is true, why might presidents often worry about what the Fed might do to interest rates?
6. What is meant by “rational” expectations? Why does the hypothesis of rational expectations have such stunning implications for economic policy? Would believers in rational expectations want to shorten a recession by expanding aggregate demand? Would they want to fight inflation by reducing
5. Explain why expectations of inflation affect the wages that result from labor-management bargaining.
4. What is a Phillips curve? Why did it seem to work so much better in the period from 1954 to 1969 than it did in the 1970s?
3. Why is it said that decisions on fiscal and monetary policy are, at least in part, political decisions that cannot be made on “objective” economic criteria?
2. “There is no sense in trying to shorten recessions through fiscal and monetary policy because the effects of these policies on the unemployment rate are sure to be temporary.” Comment on both the truth of this statement and its relevance for policy formulation.
1. When inflation and unemployment fell together in the 1990s, some observers claimed that policy makers no longer faced a trade-off between inflation and unemployment.Were they correct?
2. Long-term government bonds now pay approximately 4 percent nominal interest. Would you prefer to trade yours in for an indexed bond that paid a 3 percent real rate of interest? What if the real interest rate offered were 2 percent? What if it were 1 percent? What do your answers to these
1. Show that if the economy’s aggregate supply curve is vertical, fluctuations in the growth of aggregate demand produce only fluctuations in inflation with no effect on output.
5. Given the current state of the economy, what sort of fiscal-monetary policy mix seems most appropriate to you now? (Note: There is no one correct answer to this question. It is a good question to discuss in class.)
4. Explain the difference between crowding out and crowding in. Given the current state of the economy, which effect would you expect to dominate today?
3. Newspaper reports frequently suggest that the administration(regardless of who is president) wants the Fed to lower interest rates. In view of your answer to Test Yourself Question 3, why do you think that might be the case?
2. Comment on the following: “Deficit spending paves the road to ruin. If we keep it up, the whole nation will go bankrupt. Even if things do not go this far, what right have we to burden our children and grandchildren with these debts while we live high on the hog?”
1. Explain how the U.S. government managed to accumulate a debt of over $14 trillion. To whom does it owe this debt? Is the debt a burden on future generations?
3. If the Federal Reserve lowers interest rates, what will happen to the government budget deficit? (Hint: What will happen to tax receipts and interest expenses?) If the government wants to offset the effects of the Fed’s actions on aggregate demand, what might it do? How will this action affect
2. Explain in words why the structural budget might show a surplus while the actual budget is in deficit. Illustrate your answer with a diagram like Figure 6.
1. Explain the difference between the budget deficit and the national debt. If the deficit gets turned into a surplus, what happens to the debt?
9. In December 2008, the Fed reduced the federal funds rate to approximately zero. What should it have done then? Why? What did it actually do?
8. During the year 2008, U.S. economic performance deteriorated sharply. Can this decline be blamed on inferior monetary or fiscal policy? (You may want to ask your instructor about this question.)
7. Many observers think that the Federal Reserve succeeded in using deft applications of monetary policy to “finetune”the U.S. economy into the full-employment zone in the 1990s without worsening inflation. Use the data on money supply, interest rates, real GDP, unemployment, and the price
6. Explain why lags make it possible that policy actions intended to stabilize the economy will actually destabilize it.
5. Explain why their contrasting views on the shape of the aggregate supply curve lead some economists to argue much more strongly for stabilization policies to fight unemployment and other economists to argue much more strongly for stabilization policies to fight inflation.a. First assume that
4. Given all the pros and cons, do you think the Federal Reserve should try to prevent asset price bubbles from forming? If so, how would it do that?
3. Distinguish between the expenditure lag and the policy lag in stabilization policy. Does monetary or fiscal policy have the shorter expenditure lag? What about the policy lag?
Given the behavior of velocity shown in Figure 1, would it make more sense for the Federal Reserve to formulate targets for M1 or M2?
5. Explain why their contrasting views on the shape of the aggregate supply curve lead some economists to argue much more strongly for stabilization policies to fight unemployment and other economists to argue much more strongly for stabilization policies to fight inflation.a. First assume that
4. Given all the pros and cons, do you think the Federal Reserve should try to prevent asset price bubbles from forming? If so, how would it do that?
3. Distinguish between the expenditure lag and the policy lag in stabilization policy. Does monetary or fiscal policy have the shorter expenditure lag? What about the policy lag?
2. Given the behavior of velocity shown in Figure 1, would it make more sense for the Federal Reserve to formulate targets for M1 or M2?
1. Use the concept of opportunity cost to explain why velocity is higher at higher interest rates.
4. (More difficult) The money supply (M) is the sum of bank deposits (D) plus currency in the hands of the public (call that C). Suppose the required reserve ratio is 20 percent and the Fed provides $50 billion in bank reserves (R = $50 billion).
3. Which of the following events would strengthen the argument for the use of discretionary policy, and which would strengthen the argument for rules?a. Structural changes make the economy’s self-correcting mechanism work more quickly and reliably than before.b. New statistical methods are found

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