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Macroeconomics 1st Edition Charles I. Jones - Solutions
Look around your dorm room and consider your daily life. About what frac-tion of goods and services that you come into contact with is produced do-mestically as opposed to abroad? How does this fraction compare with the fraction for the economy overall? If there is a difference, what do you think
Deficits and investment: Suppose the government decides to reduce taxes today by 1% of GDP, financed by higher borrowing, with the borrowing to be repaid 10 years from now with higher taxes. Discuss the various argu-ments about what effect this will have on the investment rate today.
Debt-GDP ratios and economic crises: The debt-GDP ratio in Belgium ex-ceeded 120% in the early 1990s and has fallen to just over 80% more re-cently. Italy has had a debt-GDP ratio of about 100% for the last decade.The rapid rise in Japan's debt-GDP ratio was shown in Figure 13.4. Yet none of these
Ricardian equivalence and the government budget constraint: Consider the intertemporal budget constraint in equation (13.5). Assume the interest rate is i = 5%.(a) Suppose the government cuts taxes today by $100 million. Describe three possible ways the government can change spending and taxes to
The debt-GDP ratio: This exercise allows you to use the government budget constraint to study how the debt-GDP ratio changes over time. Suppose a government has an initial debt of $5 trillion, and the nominal interest rate is 5%(a) If the government keeps its primary budget in balance, what is the
The intertemporal budget constraint with three periods: Consider an econ-omy that exists for three periods: period 1, period 2, and period 3. In each period, the government must satisfy the budget constraint Bt+1 = (1 + i)B, +G, - T ..(a) Write this budget constraint for each period.(b) What must
The budget deficits of the 1980s and 2000s: To what extent were the U.S.budget deficits of the 1980s and 2000s caused by higher spending versus lower tax revenues? Using the Economic Report of the President, explain which categories of spending or taxes were most responsible. As a share of GDP,
The government's budget constraint: What is the economic interpretation of the intertemporal budget constraint in equation (13.6)? Does this inter-pretation apply to the primary budget deficit or the total deficit? Why?
The U.S. federal budget: Table 13.1 reports the composition of the federal budget as a percentage of GDP in 2005. Create a similar table using the lat-est available data from the Economic Report of the President. Has the com-position of spending and taxes changed? What about the budget balance?
Revisiting the effect of the booming European economy (hard): Reread the aggregate demand shock example (event #3) in Section 12.5. Suppose the parameters of the AS and AD curves take the following values: a = 2%, b =1/2, m = 1, u = 1/2, and w = 3%. Solve for the value of short-run output and the
Revisiting the inflation shock (hard): Reread the inflation shock example(event #1) in Section 12.5. Suppose the size of the shock is 00.(a) In the AS/AD graphs describing the response of the economy to the in-flation shock, we labeled the initial response of inflation as 71 and ini-tial output as
Can the Fed permanently increase employment? "The Federal Reserve is obsessed with inflation, so much so that it ignores the fact that millions of American workers are unemployed. We need a Fed that fights for Ameri-can jobs. We need a Fed that views any unemployment as too much unem-ployment,
Analyzing remarks by the Federal Reserve chair: Suppose your job is to ex-plain Federal Reserve policy to the CEO of a corporation. Look at a speech by the Fed chair on www.federalreserve.gov/Boarddocs/Speeches/2007/. (You may use a speech from a more recent year.) Write a brief memo to your CEO
Deflation: The Japanese economy at the end of the 1990s and into the 2000s experienced several years of deflation (see Figure 12.20). Again, re-call the monetary policy rule employed in the chapter: R, - F = m("; - T), where T = 2%, m = 1/2, and ₸ = 2%.(a) Compute the level of the (nominal)
The coefficient on inflation in the nominal version of the policy rule: Con-sider the policy rule for the nominal interest rate in equation (12.5). Draw a graph with the inflation rate on the horizontal axis and the nominal in-terest rate on the vertical.(a) What is the slope of this line? Is it
Crowding out: Consider a simplified version of the Taylor rule, where mon-etary policy depends only on short-run output:R. - T = nY.(a) Draw an IS-MP diagram, but instead of the usual MP curve, plot the simplified version of the Taylor rule. You might label this curve MPR for "monetary policy
A monetary policy rule that completely offsets aggregate demand shocks:Our monetary policy rule responds only to shocks to the inflation rate. We saw in Section 12.5 that this means that aggregate demand shocks can cause the economy to undergo a "boom-recession" cycle. Create your own monetary
The Taylor rule: John Taylor of Stanford University proposed the follow-ing monetary policy rule:Ri -T = m(m, - 7) + ny.That is, Taylor suggests that monetary policy should increase the real in-terest rate whenever output exceeds potential.(a) What is the economic justification for such a rule?(b)
The slope of the AD curve:(a) Why does the AD curve slope downward?(b) If the AD curve were more steeply sloped, how would the economy re-spond differently to aggregate demand shocks (shocks to @)?(c) If the curve were more steeply sloped, how would the economy respond differently to aggregate
The slope of the AS curve:(a) Why does the AS curve slope upward?(b) If the AS curve were more steeply sloped, how would the economy re-spond differently to aggregate demand shocks (shocks to a)?(c) If the curve were more steeply sloped, how would the economy respond differently to aggregate supply
Reinflation in Japan: In the late 1990s and early 2000s, inflation was ac-tually negative in Japan (look back at Figure 12.20). This question asks you to explore a change in policy to achieve a higher inflation rate.Consider an economy that begins with output at potential and an in-flation rate of
A decline in foreign demand for U.S. goods: Suppose the European and Japanese economies succumb to a recession and reduce their demand for U.S. goods for several years. Using the AS/AD framework, explain the macroeconomic consequences of this shock, both immediately and over time.
A negative oil price shock: It is common to blame some of the poor macro-economic performance of the 1970s on the rise in oil prices. In the mid-dle of the 1980s, however, oil prices declined sharply. Using the AS/AD framework, explain the macroeconomic consequences of a one-time neg-ative shock to
E-commerce and monetary policy: In the context of the money supply-and-demand diagram, explain the effects of financial innovations like e-commerce and the increased prevalence of credit card readers in stores. Are the ef-fects possibly related to the fact that central banks in most countries
The new economy of the late 1990s: Between 1995 and 2000, the U.S. econ-omy experienced surprisingly rapid growth, termed the "new economy" by some observers. Was this a change in potential output or short-run output?Alan Greenspan, Fed chairman, argued it was a change in potential and did not
The productivity slowdown and the Great Inflation: Using the IS-MP dia-gram and the Phillips curve, explain how the productivity slowdown of the 1970s may have contributed to the Great Inflation. In particular, answer the following:(a) Suppose growth in actual output is slowing down, as shown in
Changing the slope of the Phillips curve: Suppose the slope of the Phillips curve-the parameter 5-increases. How would the results differ from the Volcker disinflation example considered in the chapter? What kind of changes in the economy might influence the slope of the Phillips curve?
The consumption boom revisited: Go back to exercise 3 and explain what happens in the full short-run model (including the Phillips curve and al-lowing the economy to evolve over time). Do this for both parts (a) and (b), and be sure to provide graphs of output and inflation over time.
Immigration and inflation: Suppose a large number of new immigrants en-ter the labor market. Assume this increase in the supply of labor provides a drag on wage increases: wages rise by less than the prevailing rate of in-flation over the next year. Use the short-run model to explain how the
An oil price shock (hard): Suppose the economy is hit by an unexpected oil price shock that permanently raises oil prices by $10 per barrel. This is a temporary increase in o in the model: the shock o becomes positive for one period and then goes back to zero.(a) Using the full short-run model,
The summary diagram: The end of Section 11.4 (page 282) contains a sum-mary of the short-run model. Explain the economic reasoning that under-lies each step in this summary.
Your day as chair of the Fed (II): With the goal of stabilizing output, ex-plain how and why you would change the interest rate in response to the following shocks. Show the effects on the economy in the short run using the IS-MP diagram.(a) Consumers become pessimistic about the state of the
Your day as chair of the Fed (1): Suppose you are appointed to chair the Federal Reserve. Your twin goals are to maintain low inflation and to stabilize economic activity-that is, to keep output at potential. Why are these appro-priate goals for monetary policy? (Hint: What happens if the economy
No inflation stickiness: Suppose the classical dichotomy holds in the short run as well as in the long run. That is, suppose inflation is not sticky but rather adjusts immediately to changes in the money supply.(a) What effect would changes in the nominal interest rate (or the money supply) have on
A consumption boom: Using the IS-MP diagram, explain what happens to the economy if there is a temporary consumption boom that lasts for one period.(a) Initially, suppose the central bank keeps the nominal interest rate un-changed.(b) Suppose you are appointed to chair the Federal Reserve. What
Lowering the nominal interest rate: Suppose the Fed announces today that it is lowering the fed funds rate by 50 "basis points" (that is, by half a per-centage point). Using the IS-MP diagram, explain what happens to eco-nomic activity in the short run. What is the economics underlying the
The permanent-income theory of consumption: According to the permanent-income hypothesis, how does your consumption change in each of the fol-lowing scenarios? (The first question is answered for you.) To keep things simple, suppose the interest rate is 10% and you will live forever. Feel free to
Consumption and the real interest rate: According to the life-cycle/permanent-income hypothesis, consumption depends on the present dis-counted value of income. An increase in the real interest rate will make fu-ture income worth less, thereby reducing the present discounted value and reducing
Imports and the multiplier: The amount of goods that the U.S. economy imports might depend on the current state of the economy as well as on po-tential GDP: for example, when the economy is booming, imports usually rise. To incorporate this channel into the model, suppose the import equa-tion is
Consumption and the multiplier: Show how to derive an IS curve that in-cludes the consumption multiplier. That is, show how to derive equation(10.16). Draw a graph of the original IS curve and the IS curve that in-cludes the multiplier. Which one is flatter, and why?
Analyzing macroeconomic events with the IS curve (1): Consider the follow-ing changes in the macroeconomy. Show how to think about them using the IS curve, and explain how and why GDP is affected in the short run.(a) The Federal Reserve undertakes policy actions that have the effect of lowering the
Calculations with the IS curve: Suppose the parameters of the IS curve are a = 0, b = 1/3, r = 2% and the real interest rate is initially R = 2%. Explain what happens to short-run output in each of the following scenarios (con-sider each separately):(a) The real interest rate rises from 2% to
For the development of the rest of the short-run model in the next two chap-ters, we could just present the equation for the IS curve, Y, = a - b(R, - F), and omit the six equations and six unknowns that allowed us to derive the curve. Why, however, do you think the underlying setup of the economy
Okun's law: Suppose the economy has a natural rate of unemployment of 5%.(a) Suppose short-run output over the next four years is +1%, 0%, - 1%, and-2%. According to Okun's law, what unemployment rates would we ex-pect to see in this economy?(b) Consider another economy in which the unemployment
Measuring Y, and Y ,: A real-world problem faced by policymakers, forecast-ers, and businesses every day is how to judge the state of the economy. Con-sider the table below, showing hypothetical measures of real GDP in the coming years, starting at a level of $14.0 trillion in 2010.Actual Potential
An oil shock: Consider an economy that begins with output at its potential level and a relatively high inflation rate of 6%, reflecting some recent oil price shocks. As the head of the Federal Reserve, your job is to pick a se-quence of short-run output levels that will get the rate of inflation
Overstimulating the economy: Suppose the economy today is producing output at its potential level and the inflation rate is equal to its long-run level, with w = 2%. What happens if policymakers try to stimulate the econ-omy to keep output above potential by 3% every year? How does your an-swer
How can you "see" the Phillips curve operating in the graph of inflation in Figure 9.4?
When was the largest recession of the last 50 years, and what was the cu-mulative loss in output over the course of the slowdown?
Reflections on a classic: A Monetary History of the United States, 1867 to 1960, by Milton Friedman and Anna Schwartz, is a classic study of mone-tary policy, published in 1963. Read the interview with Anna Schwartz available at www.minneapolisfed.org/pubs/region/93-09/int939.cfm, and explain what
A formula for the inflation tax (hard): As in exercise 13, the amount of money the government raises from the inflation tax is AM.(a) Write this amount as a ratio to nominal GDP. Multiply and divide by M to get an expression for the ratio of revenue from the inflation tax to GDP that is the product
Revenue from the inflation tax: The amount of money the government raises from the inflation tax is AM. Consult the statistical tables at the back of the Economic Report of the President (available online) to answer the fol-lowing questions:(a) How much currency was in circulation in 1981? What was
Interest rates: The Fisher equation relates real (r) and nominal (i) inter-est rates to the rate of inflation (m). Given two of these values below, cal-culate the third.(a) r = 1%, T = 3%. What is i?(b) Tr = 5%, i = 10%. What is r?(c) r = 2%, i = 6%. What is ₸?(d) r = 1%, T = 12%. What is i?(e) =
Calculating inflation: Compute inflation rates in the following cases.(a) Suppose the consumer price index in the future takes the following val-ues: P2010 = 110, P2011 = 113, P2012 =118, P2013 =120, P2014 =125.Viewing these price levels as prevailing at the end of each year, calcu-late the
How much is that? Using the data on the consumer price index reported in Table 8.1, calculate the value in 2005 of the following items (refer to the nearest year in the table to do each calculation):(a) The salary of a worker in 1900: $1,000 per year.(b) Babe Ruth's salary in 1932: $80,000.(c) A
Explain how a rise in M ., V, and Y, affects the price level according to the quantity theory.
GDP per hour: Assume annual hours worked per person aged 16-64 in the United States is equal to 1,000. Using the data from Table 7.2 and the data from the "Country Snapshots" file (snapshots.pdf), compute GDP per hour for the other countries in Table 7.2 for the year 2000. (You can assume that
How much is a college education worth? In the text, we supposed a college education raised a person's wage by $30,000 per year, from $40,000 to$70,000. Assume the interest rate is 3% and there is no growth in wages, and answer the following.(a) Suppose you are a high school senior and deciding
Valuing human capital with wage growth: To make the calculation of the present discounted value of a worker's human capital more realistic, sup-pose labor income starts at $50,000 initially, but then grows at a constant rate of 2% per year after that. Let w, be labor income in year t, so that W+ =
The value of your human capital: Review the discussion of the value of a typical worker's human capital in Section 7.5 on pages 180-81.(a) Recompute the present discounted value in the following cases: R = 0.01, R = 0.02. R = 0.04, R = 0.05.(b) What is the economic intuition for why the present
Present discounted values (I): Compute the present discounted value of the following income streams. Assume the interest rate is 3%.(a) $50,000, received 1 year from now.(b) $50,000, received 10 years from now.(c) $100 every year, forever, starting immediately.(d) $100 every year for the next 50
How many missing jobs? Suppose the U.S. unemployment rate in 2005 had been 4.5% instead of 5.1%. How many more people would have been work-ing (assuming the labor force remained the same)?
In the last 50 years, both the fraction of hours worked by college graduates and the relative wage of college graduates have gone up. Why?
The combined Solow-Romer model (II, hard): Now let the production func-tion for output be Y, = A,K"LL, ". That is, we've made the exponent on cap-ital a parameter (a) rather than keeping it as a specific number. Notice that this affects the exponent on labor as well, in order to preserve constant
The combined Romer-Solow model (I): Make one change to the basic com-bined model that we studied in this appendix: let the production function for output be Y, = A,K}"4L34. That is, we've reduced the exponent on capital and raised it on labor, to preserve constant returns to objects.(a) Solve for
Transition dynamics in the combined Solow-Romer model: Consider the combined model studied in this appendix. Suppose the economy begins on a balanced growth path in the year 2000. Then in 2030, the depreciation rate d rises permanently to the higher level d'.(a) Graph the behavior of output per
Balanced growth: Suppose we observe the following growth rates in various economies. Discuss whether or not each economy is on its balanced growth path.(a) A European economy: gy/L = 0.03, gx/z = 0.03.(b) A Latin American economy: gy/L =0.02, g/L =0.01.(c) An Asian economy: gy/1 = 0.06, g/L. = 0.15.
Growth accounting: Consider the following (made-up) statistics for some economies. Assume the exponent on capital is 1/3 and that the labor compo-sition is unchanged. For each economy, compute the growth rate of TFP.(a) A European economy: gy/L. = 0.03, gk/L = 0.03.(b) A Latin American economy:
A variation on the Romer model: Consider the following variation:Y, = AV2Lyt, AA, = ZA,Lat, Lyt + Lat = N, La = EN.There is only a single difference: we've changed the exponent on A, in the production of the output good so that there is now a diminishing marginal product to ideas in that sector.(a)
Numbers in the Romer model (II): Now suppose the parameters of the model take the following values: Ao = 100, ( = 0.06, z = 1/3,000, and /V = 1,000.(a) What is the growth rate of output per person in this economy?(b) What is the initial level of output per person? What is the level of out-put per
Numbers in the Romer model (I): Suppose the parameters of the Romer model take the following values: Ao = 100, ( = 0.10, z = 1/500, and NV = 100.(a) What is the growth rate of output per person in this economy?(b) What is the initial level of output per person? What is the level of out-put per
An increase in the initial stock of knowledge: Suppose we have two economies-let's call them Earth and Mars-that are identical, except that one begins with a stock of ideas that is twice as large as the other: Agarth =2 X AMars. The two economies are so far apart that they don't share ideas, and
An increase in research productivity: Suppose the economy is on a balanced growth path in the Romer model, and then, in the year 2030, research pro-ductivity z rises immediately and permanently to the new level z'.(a) Solve for the new growth rate of knowledge and yt.(b) Make a graph of y, over
Calculating growth rates: What is the growth rate of output per person in Figure 6.2? What are the growth rates of output per person before and af-ter the changes in the parameter values in Figures 6.3 and 6.4?
Increasing returns and imperfect competition: Suppose a new piece of com-puter software-say a word processor with perfect speech recognition-can be created for a onetime cost of $100 million. Suppose that once it's created, copies of the software can be distributed at a cost of $1 each.(a) If Y
Nonrivalry: Explain whether the following goods are rivalrous or nonrivalrous:(a) Beethoven's Fifth Symphony, (b) a portable music player, (c) Monet's paint-ing Water Lilies, (d) the method of public key cryptography, (e) fish in the ocean.
The growth rate of output in the Romer model is zeN. Why does each of these parameters belong in the solution?
Suppose a friend of yours decides to write a novel. Explain how ideas and objects are involved in this process. Where do nonrivalry and increasing re-turns play a role? What happens if the novel is sold at marginal cost?
What happens with no diminishing returns? Consider a Solow model where the production function no longer exhibits diminishing returns to capital accumulation. This is not particularly realistic, for reasons discussed in Chapter 4. But it is interesting to consider this case nonetheless because of
Growth rates in the Solow model (II): Suppose an economy begins in steady state and is characterized by the following parameter values: s = . 2, d =. 1, A = 1, L = 100. Apply your answer to question 8 to calculate the growth of per capita GDP in the period immediately following each of the changes
Growth rates in the Solow model (I):(a) Use the production function in equation (5.6) and the rules for comput-ing growth rates from page 48 of Chapter 3 to write the growth rate of per capita GDP as a function of the growth rate of the capital stock.(Hint: Because the labor force is constant, the
Per capita GDP in the long run: Suppose an economy begins in steady state.By what proportion does per capita GDP change in the long run in response to each of the following changes?(a) The investment rate doubles.(b) The depreciation rate falls by 10%.(c) The productivity level rises by 10%.(d) An
Predicting steady states and growth rates: Consider the data in this table.Per capita Investment TFP Country GDP, 2000 Rate s (%)A United States 1.000 20.6 1.000 Ireland 0.792 19.7 0.967 France 0.672 23.8 0.691 Japan 0.741 31.6 0.679 South Korea 0.477 34.0 0.563 Spain 0.542 23.4 0.614 Argentina
Foreign aid: Consider a Solow economy that begins with a capital stock equal to $300 billion, and suppose its steady-state level of capital is $500 billion. To its pleasant surprise, the economy receives a generous gift of for-eign aid in the form of $100 billion worth of capital (electric power
An increase in the labor force: Consider a one-time change in government policy that immediately and permanently increases the level of the labor force in an economy (such as a more generous immigration policy). In par-ticular, suppose it rises permanently from L to L'. Assuming the economy starts
An earthquake: Consider a Solow economy that begins in steady state. Then a strong earthquake destroys half the capital stock. Use a Solow diagram to explain how the economy behaves over time. Draw a graph showing how output evolves over time, and explain what happens to the level and growth rate
An increase in total factor productivity: Suppose the level of TFP in an economy rises permanently from A to A'.(a) Assuming the economy starts in its initial steady state, use the Solow model to explain what happens to the economy over time and in the long run.(b) Draw a graph showing how output
A decrease in the investment rate: Suppose a country enacts a tax policy that discourages investment: suppose the policy reduces the investment rate immediately and permanently from s to s'. Assuming the economy starts in its initial steady state, use the Solow model to explain what happens to the
What determines whether a curve shifts in the Solow diagram? Make a list of the parameters of the Solow model, and state whether a change in each parameter shifts a curve (which one?) or is simply a movement along both curves.
What is the solution of the Solow model for consumption per person in the steady state, c* = C*/L *? How does each parameter in the solution affect c *, and why?
Add another line, period 6, to Table 5.1. What are the values of K6, 16, dK6, and AK6?
Institutions and economic performance: Read the article on institutions by Mancur Olson, cited in footnote 8. (You may be able to find it on the Web by typing the author's name and a few words from the title into Google Scholar.) The last sentence of that paper says that "individual rationality is
The importance of capital versus TFP: Create a new table that contains only the last three columns of the table in exercise 5. This time, instead of re-porting the numbers relative to the U.S. value, report the inverse of these numbers. For example, you should have found that per capita GDP in
Fitting the model with a higher capital share: Repeat exercise 5, but this time assume the production function is given by Y = AK3/4/1/4. That is, assume the exponent on capital is 3/4 rather than 1/3 so that the diminishing returns to capital are less. In part (d), be sure to compare the results
The empirical fit of the production model: The table below reports per capita GDP and capital per person in the year 2000 for 10 countries. Your task is to fill in the missing columns of the table.(a) Given the values in columns 1 and 2, fill in columns 3 and 4. That is, compute per capita GDP and
Solving the production model: Suppose the production function at the core of our model is given by Y = AK3/4L1/4 (that is, assume the exponents on cap-ital and labor are 3/4 and 1/4 rather than 1/3 and 2/3).(a) Create a new version of Table 4.1 for the new version of the model. What are the five
The Black Death: In the middle of the fourteenth century, an epidemic known as the Black Death killed about a third of Europe's population, about 34 mil-lion people. While this was an enormous tragedy, the macroeconomic conse-quences might surprise you: Over the next century, wages are estimated to
The "per person" versions of production functions: Write each production function given below in terms of output per person y = Y/L and capital per person k = K/L. Show what these "per person" versions look like in a graph with k on the horizontal axis and y on the vertical axis. (Assume A is some
Returns to scale in production: Do the following production functions ex-hibit increasing, constant, or decreasing returns to scale in K and L? (As-sume A is some fixed positive number.)(a) Y = KU/21,1/2(b) Y = K2/31,2/3(c) Y = KU3L, 1/2(d) Y = K + L(e) Y = K + K 1/3L,1/3(f) Y= KU31,23+ A(g) Y =
What is the purpose of macroeconomic models? How can a model of ice cream production be used to explain 50-fold income differences across countries?
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