ESSAY QUESTIONS (Total points
Provide brief answers to the
following questions. Donâ€™t write long explanations. Use graphs and notations as
given in class /textbook. Also, be neat in your works. Poor labeling (of
graphs) can cost you significant points. The space provided for each question
indicates is enough for writing your answer. In case you need extra space, you
can use the back page.
Chapter 3 Production and National
Income (30 points). (This question is similar to one of the questions in the
homework whose solution was partly provided)
a. Suppose the production output in Macro Land only
depends on two types of workers and with some level of technology. The production
is described by the following:
Y=AU0.4S0.7?where : whereYis the output,Uis low-skilled labor,Lis skilled labor,
andAis technology parameter. BothU
andSare the inputs in the production.?a. Show that the production function
exhibits increasing returns to scale?(5 points)
b. Suppose that 10%
of the skilled workers in Macro Land emigrate to foreign countries (brain
drain), while the number of unskilled labor does not change. What will be the
effect on the real wages of unskilled and skilled workers? By how much will
they change? You need to show the calculation.(10 points)
c. Now, assuming
that the 10% decrease in the skilled workers is compensated by a 10% increase
in the level of technology employed in the production (in other words,Aincreases by 10%). What will be the effect on the real wages of unskilled
and skilled workers? By how much will they change? Does the technological
progress benefit the low-skilled workers? You need to show and explain your
Chapter 3 Production and
National Income (25 points)
2. Assume a closed
economy. Suppose that the government increases taxes and government purchases
by equal amounts. What happens to the interest rate, investment, and
consumption in response to this balanced-budget change? Explain how your answer
depends on the marginal propensity to consume.
a. Using the
framework discussed in class and the textbook, explain the effect on this
policy on consumer spending. (5 points)
b. Use a
fully-labeled diagram to explain the effect of the policy on the interest rate
and investment. Write two brief sentences to explain your diagram. (10 points)
c. Using the
framework and equations discussed in class and the textbook, how does your
answer in parts (a) and (b) above depend on the marginal propensity to consume?
Explain. (10 points)
3. Chapters 4-5 Money,
Inflation, and Monetary Policy (30 points)
From January 2007
to September 2013, the US monetary base has more than tripled, increased from
$813.38 billion to $3.429 trillion. Yet, over the same period, the money
supply, measured by M2, only increased by 52%, up from $7.081 trillion to
a. Using the
framework and equations discussed in class and the textbook, explain why, in
general, the growth rate of money supply can be much slower than the growth
rate of monetary base.(5 points)
b. Now, put your
explanations above within the context of the US economy in the last five years.
How do you explain the slow growth in the money supply in compared to the rapid
growth in the monetary base?(7.5 points)
c. In light of your
answer in part (b) and using the framework and equations discussed in class and
the textbook, should we expect higher inflation rates both in the short-run and
long-run? Explain.(7.5 points)
d. How does your
answer in part (a) and (b) depend on currency-to-deposit ratio and
reserve-to-deposit ratio? If the Fed imposes a policy that all commercial banks
must lower their reserve-to-deposit ratio, what would be the effect on money
supply and inflation?(10 points)
4. Chapter 6 Open Economy (20
Assume that the
nominal exchange rate for the euro is .75 euros per dollar. Suppose that a
Volkswagen Golf costs 15,000 euros in Germany, while it costs $20,000 in the
a. What is the real
exchange rate? Does purchasing power parity hold?
b.Suppose that the expected inflation rate is 3 percent in the United States
and 8 percent in European Union. The real interest rate is 2 percent in both
countries. What is the nominal interest rate in each economy?
c. Suppose the
percentage change in nominal exchange rate is 3 percent. What is the expected
percentage change in the real exchange rate?
d. What would the
nominal exchange rate have to be for purchasing-power parity to hold?
5. Chapter 6 Open Economy (30
Suppose Amazon is a
small, open economy. The country is experiencing twin deficits (budget deficit
and trade deficit). Some policy makers and economic analysts in the country
propose that the solution to both problems (deficits) is to enact a
contractionary fiscal policy.
a. Using the
framework and equations discussed in class and the textbook, analyze the merit
of the policy.
b. Using a
fully-labeled diagram, analyze the merit of the policy above and explain your
diagram in two sentences.
c. Suppose also
that the policy makers in Amazon are worried about the appreciation of their
currency, Azin. To prevent the appreciation of Azin, the government of Amazon
pegs Azin against world major currency as well as the currencies of their main
trading partners. That means the real exchange rate is fixed at some level.
Analyze the effectiveness of the contractionary fiscal policy above in solving
the twin-deficit problem.
6. Chapter 7 Unemployment and
a. Recently, the US
government has extended the unemployment insurance to almost two years. Analyze
the effect of this policy on: (20 points)
i. finding rate?ii.
separation rate?iii. unemployment rate
Bonus question (5
b. If the
unemployment insurance is replaced by a one-time support for unemployed people
for six months, how do you think your answers will be different from part (a)