1. 1. Explain how changes in wealth and changes in population can affect labour supply and equilibrium employment and wage rate.
   2. An economy can never experience an increase in the unemployment rate and the creation of more jobs at the same time. True or False? Explain.
2. 1. Briefly describe the effects on measured national income for one year (using the expenditure approach) of the following activities:
   • A mother with two preschool children in Day Care at a cost of $10,000 each per year, leaves her full-time job paying $40,000 per year to care for her children at home instead.
   • INCO builds a $400 million smelter which emits 40 million tons of sulfur dioxide into the atmosphere per year during production of $100 million of nickel ingots.
   • INCO spends $100 million to install scrubbers in its new smelter which reduce emissions to 1 million tons per year.
   2. Briefly describe the shortcomings of how government services are accounted for in the national income accounts. (Hint: many such services do not pass through markets).
3. 1. Show how a temporary increase in government expenditures affects the current account. How is this related to the "twin deficits" problem?
   2. How would a temporary decrease in taxes affect the current account? How does the Ricardian Equivalence proposition affect your answer?
4. Suppose that Japan and the remaining Asian economies can be thought of as a two country world.
   1. Assume that Japan is a net lender and graphically describe the two country current account equilibrium.
   2. Suppose that a temporary adverse supply side shock hits Japan. What are the effects on the other economy's current account and the equilibrium world interest rate?
   3. How does the analysis in (b) relate to crises in Lesser Developed Coutries (LDCs)?
5. A closed economy has governmental purchases of 200. The desired savings and investment levels are given by

   S^d = 30 + 200r + 0.1Y - 0.2G

   I^d = 120 - 600r

   1. When the full employment output equals 500, calculate the real interest rate that clears the goods market. Illustrate this on a diagram.
   2. Solve for the levels of consumption, C, and national saving, S.
   3. Suppose the government increases its spending by 50. Using the given equations, what are the effects on r, C and I?
   4. Explain the results in part (c) in terms of "crowding out."
6. Consider the illustration below: [Not shown]
   1. What is "real GDP" and what is the underlying concept which economists use real GDP to measure?
   2. What business cycle term would economists use to describe the time period between 1981:1 and 1982:4? What term describes the period following 1982:4?
   3. How would you expect aggregate unemployment rates to behave over these time periods, given the information on GDP contained in the illustration?
   4. What was the average annual growth rate of Canadian Real GDP for the 5 years between the beginning of 1981 and the end of 1985?
7. A large chain of office equipment stores does a study of the relationship between its capital stock and subsequent sales at its various outlets. It finds the following relationship:

   Capital Stock	Sales
   100	40
   101	64
   102	76
   103	82
   104	85.5

   1. Write down the marginal product of capital (at all levels of capital stock).
   2. If the user cost of capital is 11, what will be the firm's optimal level of capital?
   3. The current capital stock is 100, and the firm wishes to invest so as to reach the optimal level by the next period. If the rate of depreciation of this capital is 5%, what will be the firm's gross investment?
8. Build a simple balance of payments table with the data below.
1. Include each item in the current or capital account as appropriate.
2. Indicate the sign (+ or -) of the item.
3. Calculate the required value for official reserve assets.
4. Explain why the value for official reserves has that sign.

Items:



Exports of Goods	100
Domestic Assets purchased by foreign interests	50
Imports of Goods	90
Investment income received from foreign interests	40
Foreign Assets purchased by Canadians	30
Imports of Services	150
Exports of Services	180
Investment income paid to foreign interests	90
Canadian official reserve assets	?

9. Make a table like that shown below and indicate how each item below will affect the relevant measures of money supply. (ie. + or - and the amount)

   1. Take $10 from personal chequing and deposit it in a US$ account.
   2. $10 from a deposit with a credit union is shifted to a bank current account.
   3. You find $10 under your bed and deposit it in your savings account.
   4. Shift $10 from a savings account to a 3 year certificate of deposit.
   5. The proceeds from a 3 year certificate of deposit ($10) are invested in money market mutual funds.

   Item	M1	M2	M2+	M3
   1	.	.	.	.
   2	.	.	.	.
   3	.	.	.	.
   4	.	.	.	.
   5	.	.	.	.

ANSWERS:

1.

1. An increase in wealth reduces labour supply. This causes the labour supply curve to shift to the left. Equilibrium wage rate rises and employment falls.
2. An increase in population increases the labour supply. This causes the labour supply curve to shift to the right. Equilibrium wage rate falls and employment rises.
3. False.

   The unemployment rate is defined as

   

   If more jobs are created, # employed must increase. However, if the size of the labour force increases drastically, leading #unemployed to rise by a greater proportion than the increase in labour force, the unemployment rate can increase at the same time.

   For example,

   #employed = 3, #unemployed = 1, so that U.R.=0.25 to start with.

   Then suppose #employed increases by 1 while #unemployed increases by 3. Now, U.R = 0.5. Hence, the unemployment rate and the number of workers employed have risen simultaneously.

2.

1. i) Day care services fall by 2 x $10,000 = $20,000 [since two children] so that consumption, C, falls by $20,000. Output from the mother's employment falls by $40,000, so Y=C+I+G+(X-M) also falls by $40,000. The total reduction is $60,000. The value of care in the home is not counted in GDP since it is a non-market activity.

   ii) Investment increases by $400m. In terms of goods produced:
   

   • If unchanged from the previous period there is no GDP change
   
   
   • If the production is new output, Y (GDP) rises by 100.
   • Some part of the investment, I, is an input to new output and should be netted out of the 400.

   The costs of pollution are not marketed and are consequently ignored in GDP measurement. Introduction of a pollution permit system could help to remedy this deficiency.

   iii) Investment rises by $100m. Again, since pollution is not marketed, its reduction is omitted from the GDP calculation.



2. Government output is valued as a "cost" incurred by the government. Its value to society is not known with certainty since it does not pass through a market. Thus, we know the cost of making a transfer (eg. if Tax=$100 and Transfers=$80, then Cost=$20), but we do not know how much the society values making such a transfer: it could be $50, $5, or any other amount.

3.

1. Draw the I-S equilibrium for an open economy. An increase in G implies that C and S must fall with Y fixed (no labour demand or supply effects with a temporary G change). Note that consumption smoothing requires national savings to fall since C will not absorb all of the change in G. The S curve therefore shifts left and so the CA is reduced. Twin deficits refers to a deficit in the CA as well as a government deficit. The previous analysis suggests that a small CA surplus could become a deficit if the government increases its deficit. Hence, government deficits can lead to CA deficits.
2. A temporay decrease in taxes could lead to more C and S in the private sector if the tax reduction is viewed as an income increase. But then Sgov must fall and this is larger than the rise in Spvt so the CA decreases. If the public is forward looking (because of Ricardian equivalence) and realize that the current reduction must be made up with future increases in taxes then the private sector does not change its C. There is therefore an increase in Spvt which is just equal to the tax reduction (the decrease in government savings) so national savings are unchanged. Thus, there is no change in the CA.

4.

1. CA1+CA2=0. This can be shown in a diagram with the lending of one country (Japan) equal to the borrowing of the others at the world interest rate.
2. A temporary adverse supply shock means that Y falls (and so S and C fall too) but labour supply and investment do not change. Japanese S falls, so its net lending falls. At the current rate of interest, total borrowing demand (I1+I2) is greater than total savings (S1+S2) so the rate of interest must rise. I then falls and S rises until a new equilibrium is reached.
3. From b., the net borrower has a CA deficit to start with, and so the interest rate rises. Now, the amount that the developing country can borrow has fallen and if there is a fiscal deficit, interest payments will have increased. Both of these effects mean that expected investments may fall sharply and precipitate a crisis.

5.

1. Goods market equilibrium implies I^d = S^d, which yields equilibrium interest rate,

r = 0.1 = 10 %

2. S = I = 60

Using S = Y - C - G , we obtain C = Y - S - G = 240.

3. G increases to 250.

The new goods market equilibrium yields r = 0.1125 = 11.25%.

Hence, S = I = 52.5 and C = 197.5.

4. Saving, investment and consumption have fallen. The increase in government spending "crowds out" the other uses of the economy's (fixed) resources; that is, investment and consumption.

6.

1. Nominal GDP is the (current) value of final goods and services in a period for a given region. Real GDP measures a quantity of goods by removing price level changes from the value measure, thereby making it directly comparable to the GDP quantities of previous periods.
2. Recession or contraction ; Recovery, expansion or "boom"
3. The unemployment rate rises in the recession phase and falls during an expansionionary phase. It is unchanged when output is at its trend (long run) value.
4. Output goes from 550 to 630 so the growth is (630-550)/550 = 80/550 =0.145 or 14.5% during the total period. Dividing 14.5% by 5 years gives the average level of growth, 2.9% per year.

7.

1. Filling in the MPKs:

Capital stock	Sales	MPK
100	40
101	64	24
102	76	12
103	82	6
104	85.5	3.5

2. user cost of capital = 11. Thus K^* = 102.
3. K =100, depreciation rate, d = 0.05.

   Gross investment, I = K^* - K + d K = K^* - (1- d ) K = 7.

8.

1. See table below
2. See table below

   Exports of Goods	100 - CA +100
   Domestic Assets purchased by foreign interests	50 KA +50
   Imports of Goods	90 CA -90
   Investment income received from foreign interests	40 CA +40
   Foreign Assets purchased by Canadians	30 KA -30
   Imports of Services	150 CA -150
   Exports of Services	180 CA +180
   Investment income paid to foreign interests	90 CA -90
   Canadian official reserve assets	? KA -10

3. CA+KA+reserves=0; +10+Reserves=0; reserves=-10

4. Canada has sold foreign reserve assets; ie. $US were traded for $10 Canadian. This is a negative number because it reflects the purchase of a financial asset and is therefore treated as a capital outflow.

9.