Due:     Friday 24 September, 4pm

Note: The value of each question is indicated in brackets at the end of the question.

1. It is argued that the difference between Classical and Keynesian approaches to economics is a positive issue.
   a) What does "positive issue" mean in this context? (3)
   b) Briefly explain the basic arguement between Classical and Keyneian approaches.(4)
   c) Economists may disagree on issues because they do not share the same belief about important numbers in the economy. Discuss.(3)

2. a) "Government deficits have nothing to do with our foreign trade". Discuss this statement by analysing the national savings relationship. (5)
   b) Also explain how a country can increase current consumption by allowing a decrease in national wealth.(You can't have your cake and eat it too!)  (5)

3. a) Government expenditures, G, in the national expenditure = national income identity is not total government expenditures. Explain (3)
   b) GDP and GNP measure the same thing. Explain (3)
   c) Explain "Investment" as used in national income accounting. Explain carefully the investments not included by the term "Investment". (2)
   d) Why are the distinctions among the real, nominal, and real expected interest rate important? (2)

4. a) Go to CANSIM (See the course web page ; go to Other Links at the bottom) and find any price index. Note the description of the index and copy out 10 values and their associated dates. Calculate and report an inflation index for this price index.   (5)
   b) How does unemployment in Canada compare to other countries? (Check out Statistics Canada: www.statcan.ca. Look for Canadian Statistics - Labour Force employed and unemployed - Participation rates employment and unemployment - Canada and selected countries) (3)
   c) Has the Bank of Canada been able to keep the inflation rate between 1% and 3% as targeted between 1995-1999? (Use Other Links on the course web page; bank rate - weekly financial statistics. Find the CPI page.) (2)

5. You are given the following data on an economy:

   GNP	$1,000,000
   Gov Exp	200,000
   Gov Deficit	50,000
   National Savings	200,000
   Investment	150,000
   NFP	25,000

   Calculate: (2 marks each)

   a) Consumption
   
   b) Private Savings
   
   c) Disposable Income
   
   d) GDP
   
   e) Net Exports

   Assume an economy produces 3 commodities: jeans, haircuts and textbooks. The following table lists the price and quantity sold of each one of these products:
    

   	Year 1		Year 2
   	Quantity	Price	Quantity	Price
   Jeans	1000	$25	1200	$30
   Haircuts	5000	$5	4000	$5
   Textbooks	3000	$50	3000	$55

    
   

   a) Measure the rate of inflation using the CPI with year 1 as the base year. (4)
   

   b) Measure the rate of inflation using the GDP deflator. (4)
   

   c) Why are they not the same? Should they be the same in general? (2)
   

1. a) "Positive" in this context means that they disagree on the description of how the economy works. In contrast, a normative difference would consist of a statement of what *should* be done. We might agree that a "brain drain" exists because of taxes, but some would propose tax cuts and others would not. (Some could argue that the benefits of higher taxes are larger than the cost of the drain.)
   b) The Classical approach assumes that an appropriate description of the economy includes markets which clear quickly. That is, prices for goods and services (including labour and capital) will change quickly in response to demand and supply fluctuations, so that markets can be assumed to maintain equilibrium. These flexible prices then provide all the information necessary for economic decision making. Maximizing individuals and flexible prices allow the econmy to produce as much as is possible. Full employment is a prediction.
   The Keynesian approach assumes that flexible prices are not a good description of the economy. Rather, prices do not change quickly. This means that there may be markets which are not in equilibrium; ie. demand does not equal supply. The price system does not produce the information necessary for maximum possible output. Unemployment is therefore possible for extended periods.
   c) The difference between Classical and Keynesian descriptions turns on an empirical characteristic of the economy: how fast do prices respond? Do they go 10% of the way in six months or do they go 90% of the way in 1 month? Similarly, in the brain drain example above, the description of the economy may be the same: taxes do cause a brain drain but the respective numeric values on the benefits and costs of the taxes differ. For example, does a 1% tax reduction cause a 1% brain drain reduction or a 50% reduction? This is where views may differ.

2. a) Spvt = I+CA+(-Sgvt) = I+CA+deficit
   If private savings remain unchanged increases in the deficit must reduce I+CA. Even if private savings are reduced, as long as they do not completely offset the increased deficit, I+CA must fall. But if this means that the current account is affected then trade must be affected. The term "twin deficits" refers to the existence of deficits in both the current account and government savings.
   b) I+CA are additions to wealth; I adds to the stock of productive domestic capital, and CA adds to domestic claims on foreign assets. If a country is willing to let private savings fall so that it can consume more, then I+CA must fall: additions to wealth fall. If national savings were negative, consumption would almost literally be eating away national wealth.

3. a) G refers to government purchases of goods and services. It does not include transfers from one individual to another mediated by the government. Thus $100 of fedaral taxes of which $20 was transferred to Bill in an education scholarship, $40 went to interest on the debt, and $20 went to the Ontario government would count as $20 in G which is the cost of mediating the transfer.
   b) GDP measures the production in a region (typically a country) over a period of time. GNP measures the total income produced by a country's citzens over the same period. The two differ because some income is earned from activities in other countries and some foreigners have claims on output produced domestically. "Net factor payments" measures the income gained from abroad less the income paid abroad so that GDP + NFP = GNP.
   c) Investment in macroeconomics typically refers to purchases of fixed capital: you can kick it! It is an investment because the output which it will produce yields stream of revenue over an extended period of time. This is to be distinguished from financial investment: stock, bonds, and other financial instruments in which you buy title to a promised income stream. Note that purchases of stocks and bonds are financial investment. The proceeds of this sale may be used for real investment if they are used to buy productive capital.
   d) Each describes a different rate of return. The nominal rate describes the total interest that will be paid over a period of time, say 10% this year. Barring default, 10% will be received. The real rate takes account of the current inflation rate. It measures how much better one really is at the end of the period. If the current inflation is 4% and does not change, the nominal 10% will yield only 10-4 = 6% real rate of return. You will be only able to buy 6% more since the price level has increased by 4%. Most financial decisions are based on the expected real rate since inflation might change after a deal is made. What counts is the real rate that we expect to earn in the future ; expected real rate = nominal rate - expected inflation.

4. a) Inflation is calculated as P(t+1)-P(t) / P(t) = change in P/P = % change in price
   b) Canada seems to have a smaller participation rate than US and Japan but Japan has a lower female participation rate. Canada has the highest unemployment rates relative to US, Japan, Aus, and New Zealand.
   c) Both the CPI and Core CPI fell below the 1% band in mid 1997-mid 1998. The current trend seems to be an increasing CPI just short of 2%.
   
   
5. d) GDP = GNP-NFP = $975,000

   e) Spvt+Sgov=I+CA
   200,000 = 150,000 + CA ; CA = 50,000
   CA = I + NX + NFP = 150,000 + NX + 25,000 ; NX = 25,000

   b) Spvt = I + CA - Sgov = 200,000 - (-50,000) = 250,000

   a) Y = C + I + G +NX
   975 = C + 150,000 + 200,000 + 25,000
   C = 600,000

   c) DY = Y + NFP +TR + INT - T
   TR = 0 and INT =0 but Deficit = G-T so T=200,000 - 50,000
   = 975 + 25 + 0 + 0 - (150,000)
   = 850

6. CPI is fixed weight; GDP deflator is variable weight.

   
   a) CPI(1) = 100
   CPI(2) = base year output at current prices/ base year output at base year prices
   = 1000*30+5000*5+3000*55/1000*25+5000*5+3000*50
   = 1000*(30+25+165)/1000*(25+25+150)
   = 110/100
   =110
   Inflation = CPI(2)-CPI(1) / CPI(1) = 110-100/100 = 10%

   b) GDP def(1) = 100
   GDP def(2) = current basket at current prices/ current basket at old prices.
   = 110.5
   Inflation = 10.5%

   c) The deflator shows a higher inflation rate because the consumption bundle changed over the period toward more expensive jeans and textbooks and away from less expensive haircuts. In general, both prices and consumption bundles change over time. The variable weight measures tends to keep up with these changes but the fixed weight index does not adjust for the change in the bundle purchased. In general we would expect the two to differ.