Due Date: Thursday, September 8th (at the beginning of class)



Due Date: Monday, December 3rd

INSTRUCTIONS: Do these problems at your leisure. Don’t do these problems at your peril.

1) [Chapter 3] Assume that a competitive economy can be described by a constant returns to scale, Cobb-Douglas production function and all factors of production are fully employed. Holding other factors constant, including the quantity of capital and technology, carefully explain how a one-time, 10-percent increase in the quantity of labor (perhaps the result of a special immigration policy) will change each of the following:

a) the level of output produced

b) the real wage of labor

c) the real rental price of capital

d) labor’s share of total income

2) [Chapter 7] The economies of two countries, North and South, have the same production functions and depreciation rates. The economies of each country can be described by the Solow growth model.

a) Let’s say population growth is faster in South than in North, while the savings rates are the same in each country. In which country is the level of steady-state output per worker larger? In which country is the growth rate of steady-state output per worker larger? Explain.

b) Let’s say the savings rate in North is higher than in South, while population growth rates are the same in each country. . In which country is the level of steady-state output per worker larger? In which country is the growth rate of steady-state output per worker larger? Explain.

3) [Chapter 4] A classical (and very cool) economist wears a t-shirt printed with the slogan “Fast Money Raises My Interest!” Use the quantity theory of money and the Fisher equation to explain the slogan.

4) [Chapter 5] Suppose that the International Monetary Fund (IMF) is concerned about the real exchange rate in a small open economy.

a) What type of fiscal policy should the IMF propose to the government of the small open economy to generate a real exchange rate appreciation.

b) Illustrate graphically the impact of the IMF proposal on the exchange rate of the small economy.

c) What will happen to the trade balance of the small open economy, assuming that it started from a position of balanced trade?

5) [Chapter 5] Explain why government budget deficits crowd out private investment spending in a closed economy, but crowd out net exports in a small open economy. Assume prices are flexible and that factors of production are fully employed in both economies. Assume there is perfect capital mobility for the small open economy.

6) [Chapter 9] Suppose a law is passed banning labor unions and that resulting lower labor costs are passed along to consumers in the form of lower prices. Use the aggregate demand – aggregate supply model to illustrate graphically the impact in the short run and the long run of this favorable supply shock.

7) [Chapter 10] Use the Keynsian-cross model to illustrate graphically the impact of an increase in the interest rate on the equilibrium level of income. Explain in words what happens to equilibrium income as a result of the increase in the interest rate.

8) [Chapter 10] Graphically illustrate the impact of an open-market purchase by the Federal Reserve (they purchase U.S. bonds) on the equilibrium interest rate using the theory of liquidity preference and the market for real money balances. Explain in words what happens to equilibrium interest rate as a result of the open-market purchase.

9) [Chapter 11] Suppose Congress passes legislation that reduces taxes.

a) Use the IS-LM model to illustrate graphically the impact of the tax reduction on output and interest rates.

b) Compare the impact of this tax cut on consumption, investment, output, and interest rates in the classical model of Chapter 3 versus the IS-LM model.

10) [Chapter 11] A decrease in government spending reduces output more in the Keynesian-cross model than in the IS-LM model. Explain why this is true.

11) [Chapter 12] Two small open economies, Fixed and Flex, can be described by the Mundell-Fleming model. The countries are otherwise identical except that Fixed maintains a fixed exchange rate, while Flex maintains a flexible exchange-rate regime. The governments of both countries increase spending by the same amount. Compare what happens in the two countries to:

a) the exchange rate

b) equilibrium output

c) net exports

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