Instructions: This is a 2 hour exam. Non-programmable calculators are permitted. The value of each question is indicated at the start of each question.

1. (20)

Use the saving-investment diagram to analyze the effects of the following on national saving, investment and the real interest rate. Explain your reasoning.

(a) (5) Consumers become less future-oriented and thus decide to save less.

(b) (5) The government announces a large, one-time bonus payment to farmers because of a drought. The bonus will be financed by additional taxes levied on the general population over the next five years.

(c) (5) The government introduces an investment tax credit (offset by other types of taxes, so that total tax collections remain unchanged).

(d) (5) A large number of accessible oil deposits are discovered, which increases the expected future marginal product of oil rigs and pipelines. It also causes an increase in expected future income.

2. (20)

A country loses much of its capital stock to a war.

(a) (5) What effects should this event have on the country's current employment, output and real wage?

(b) (5) What effect will the loss of capital have on desired investment?

(c) (5) The effects on desired national saving of the wartime losses are ambiguous. Give one reason for desired saving to rise and one reason for it to fall.

(d) (5) Assume that desired saving doesn't change. What effect does the loss of capital have on the country's real interest rate and the quantity of investment?

3. (10)

(a) (6) In 1993 the debate heated up in Canada about the North American Free Trade Agreement (NAFTA), which proposed to reduce barriers to trade (such as taxes on, or limits on, imports) among Canada, the United States and Mexico. Some people strongly opposed the agreement, arguing that an influx of foreign goods under NAFTA would disrupt the Canadian economy, harm domestic industries and throw Canadian workers out of work. How might a classical economist respond to these concerns? Would you expect a Keynesian to be more or less sympathetic to these concerns than a classical economist? Why?

(b) (14) State how each of the following transactions would enter the Canadian balance of payments accounts (e.g. credit / debit in current / capital account). Discuss only the transactions described. Do not be concerned with possible offsetting transactions.

1. The Canadian government buys military equipment from a foreign government.
2. A London bank sells yen to, and buys Canadian dollars from, a Swiss bank.
3. The Bank of Canada sells yen to, and buys dollars from, a Swiss bank.
4. A Canadian bank receives the interest on its loans from Brazil.
5. A Canadian collector buys some ancient artifacts from a collection in Egypt.
6. A Canadian oil company buys insurance from Lloyds of London to insure its oil rigs in the Beaufort Sea.
7. A Canadian company borrows from a U.S. bank.

4. (20)

(a) (10) According to the growth accounting approach, what are the three sources of economic growth? From what basic economic relationship is the growth accounting approach derived?

(b) (10) Of the three sources of growth identified by growth accounting, which one is primarily responsible for the slowdown in Canadian economic growth after 1973? What explanations have been given for the decline in this source of growth?

5. (20)

(a) (10) Define unemployment spell and duration.

(b) (10) What are the two seemingly contradictory facts about unemployment spells? Why are the two facts not actually contradictory?

6. (10)

An economy has full employment output of 600. Government purchases, G, are 120. Desired consumption and investment are given by:

C^d = 360 - 200r +0.10Y

I^d = 120 - 400r

where Y is output and r is the real interest rate.

(a) (5) Find the equation relating desired national saving S^d to r and Y.

(b) (5) Find the real interest rate that clears the good market. Assume that output equals full-employment output.

7. (10)

Consider a firm that faces the following expected future marginal product of capital:

MPK^f = 1000 - 2K

where MPK^f is the expected future marginal product of capital and K is the capital stock. The price of capital, P_k, is 1000, the real interest rate, r, is 10% and the depreciation rate, d, is 15%.

(a) (3) What is the user cost of capital?

(b) (3) What is the value of the firm's desired capital stock?

(c) (4) Now suppose that the firm must pay a 50% tax on its revenue. What is the value of the desired capital stock?

8. (10)

Describe how the GDP deflator and the CPI are calculated. What are the basic differences between the two indexes?

9. (10)

Why are goods and services counted in GDP at market value? Are there any disadvantages or problems in using market values to measure production?

10. (10)

Suppose an economy has the following production function: Y = A K ^a L ^{1 - a}.

In a particular year, we are given the following growth rates:

What is the value of a ?