Question 2

Consider a household facing the following problem:

max U (c, h) = 2 ln c + (1 ? 2 ) ln(1 ? h)

subject to

c,h 5 5 c = wh,

where c denotes consumption, h hours worked and w is the wage.

1. Describe the trade-off that the household faces and solve for hours worked, i.e. labour
2. supply.
3. Suppose that the government introduces a proportional tax, ?, on labour income so that the budget constraint becomes c = (1 ? ? )wh. The tax revenue will be used to finance the restoration of old castles in the south of Sweden. How is the individual's labour supply affected? Motivate your answer mathematically.

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c. Suppose instead that the tax revenue is returned to households as a lump-sum transfer. Specify the government's budget constraint and explain how labour supply is affected by the tax.

1. Maintaining the assumptions in question c, suppose that the tax rate is set to ? = 0.3. Compute labour supply.
2. Suppose that the tax rate is lowered from 0.3 to 0.2. Compute the change in labour supply in percentage terms.

Question 3

Consider the AS-AD model discussed in Lecture 5. The AD curve is given by:

Y ?t = ? ? ??(?t ? ? ?), (4)

where Y ?t is short-run output, ?t is current inflation and ? ? is an inflation target pursued by the central bank. The AS curve can be written:

?t = ?t?1 + ?Y ?t + ?. (5)

1. Explain where the two equations come from and explain the intuition behind them.
2. How would you interpret ? and ?? Which values must they assume in a steady-state, i.e. in the long run.
3. Analyse the effect of making the inflation target more ambitious, i.e. the effect of lowering ? ?. Illustrate your answer in a diagram and explain the intuition.
4. Suppose that the demand for domestic goods decreases abroad, so that the export share of potential output temporarily decreases. Analyse the effects on inflation and short-run output using a diagram.

Question 4

There are different views on the causes of inflation. While the standard view is that inflation is a monetary phenomenon, others emphasise the impact of fiscal policy.

1. Explain how inflation is related to the money supply according to the quantity theory of money. Motivate your answer using equations.
2. Explain how inflation may be triggered by fiscal considerations, e.g. a desire to increase government spending. Motivate your answer by formulating the government's budget constraint.

Question 2 Consider a household facing the following problem: max U (c, h) = Inc + (1 - ; ) In(1 - h) c,h subject to c = wh, where c denotes consumption, h hours worked and w is the wage. a. Describe the trade-off that the household faces and solve for hours worked, i.e. labour supply. b. Suppose that the government introduces a proportional tax, 7, on labour income so that the budget constraint becomes c = (1 -7)wh. The tax revenue will be used to finance the restoration of old castles in the south of Sweden. How is the individual's labour supply affected? Motivate your answer mathematically.c. Suppose instead that the tax revenue is returned to households as a lump-sum transfer. Specify the government's budget constraint and explain how labour supply is affected by the tax. d. Maintaining the assumptions in question c, suppose that the tax rate is set to 7 = 0.3. Compute labour supply. e. Suppose that the tax rate is lowered from 0.3 to 0.2. Compute the change in labour supply in percentage terms. Question 3 Consider the AS-AD model discussed in Lecture 5. The AD curve is given by: Y = a - Bu(T - 7), (4) where Y is short-run output, It is current inflation and # is an inflation target pursued by the central bank. The AS curve can be written: (5) a. Explain where the two equations come from and explain the intuition behind them. b. How would you interpret o and o? Which values must they assume in a steady-state, i.e. in the long run. c. Analyse the effect of making the inflation target more ambitious, i.e. the effect of lowering 7. Illustrate your answer in a diagram and explain the intuition. d. Suppose that the demand for domestic goods decreases abroad, so that the export share of potential output temporarily decreases. Analyse the effects on inflation and short-run output using a diagram.Question 4 There are different views on the causes of inflation. While the standard view is that inflation is a monetary phenomenon, others emphasise the impact of fiscal policy. a. Explain how inflation is related to the money supply according to the quantity theory of money. Motivate your answer using equations. b. Explain how inflation may be triggered by fiscal considerations, e.g. a desire to increase government spending. Motivate your answer by formulating the government's budget constraint