Answer 4 questions from Part A and 3 questions from Part B. Part A is worth 40 marks and B is worth 60 marks. Show all your work. You have two hours: budget your time carefully. You may use a hand calculator. Do not hand in the question sheet.
Part A (40 marks) Answer 4 of the following 7 questions.
1. The Minister of Finance, Paul Martin, is considering one of the following policies to stimulate the economy:
(i) a tax cut, or (ii) an increase in government expenditure through borrowing.
Are there any real differences between these two policies? What are the main assumptions underlying your answer?
2. Suppose a new tax on wealth has been introduced. What are the predictions for employment, output and the real wage from this policy?
3. In a particular year, the nominal GDP of two countries (A and B) grew by 2.5% and 6% respectively. A news reporter concludes that standard of living grew faster in country B. Is this a valid conclusion? Why or why not?
4. Discuss the implications of an adverse supply shock for labor demand, the real wage, and the full-employment level of employment.
5. Is it possible to have both an increase in the unemployment rate and an increase in the employment ratio?
6. Suppose an economy has the following production function: Y=AK^(alpha) N^(1-alpha). If in a particular year, we are given the following growth rates: output = 6%, capital = 2%, and labour = 4% and total factor productivity =2.5%, what is the value of alpha?
7. The government of a small open economy announces a tax cut of 100 this year combined with a tax increase of 110 next year, when the interest rate is 10%. Suppose desired consumption is governed by a Keynesian consumption function.
(a) What is the effect of this change on the world real interest rate, national saving, investment, and the current account balance in equilibrium? (b) Does Ricardian equivalence hold in this case?
Part B (60 marks) Answer 3 of the following 4 questions.
1. Suppose a firm's daily output and labour input are given in the following table. (Its capital stock is fixed.)
| number of workers | output> |
| 0 | 0 |
| 1 | 11 |
| 2 | 19 |
| 3 | 26 |
| 4 | 26 |
| 5 | 35 |
| 6 | 37 |
(a) What is the marginal product of labour (MPN) for each of the entries?
(b) The firm sells its products at a price of $10/unit. If the wage rate is $55 per day, what is the firm's profit-maximizing employment level?
(c) If there is a beneficial supply shock that causes the MPN to increase by 2 at any given level of labour input, at the wage rate of $55, what will be the new profit-maximizing level of employment?
(d) Starting from the situation in (b), if the price of output increases to $15/unit, and workers also demand a higher wage, what will be the highest wage rate at which the firm will still hire the same number of workers as in (b)?
2. A firm's expected future marginal product of capital is MPKf = A(1200-2K), where K is the capital stock and A is a measure of productivity. The price of capital is 2000. The depreciation rate is 7%, the real interest rate is 5%, and the tax rate on the firm's revenues is 40%.
(a) What is the tax-adjusted user cost of capital?
(b) At A=1, what is the firm's desired capital stock?
(c) If there is an adverse supply shock that decreases A to 0.8, what will be the new desired level of capital stock?
(d) Suppose the firm's capital stock was 250 last year, and the firm is able to increase it to the desired level calculated in (b) this year. What are the firm's net investment and gross investment over this period?
3. In a small open economy,
(a) Calculate the current account balance.
(b) If this economy were a closed economy, what would be the value of r which clears the goods market? Calculate desired consumption in this case.
(c) Under the open economy assumption, suppose this economy experienced a tax cut which was exactly matched by a fall in government expenditure. What happens to private savings, government savings, and the current account balance?
4. This question explores how wealth, future income, and the interest rate affect consumption and saving. Suppose Martin's assets are denoted a, his income is denoted y, and his expected future income is denoted yf. His current consumption is c and his future consumption is cf. The present value of his consumption is limited by the present value of his resources:
c + cf /(1+r) = a + y + yf /(1+r).
Furthermore, he tries to set his consumption pattern such that 2c = cf.
(a) If a = 0, r = 0.05, y = 50 and yf =60, then what is his current consumption and saving?
(b) What is his consumption and saving if instead yf = 50?
(c) Now suppose that, at this lower level of expected future income, the interest rate rises to r = 0.08. What is his consumption and saving? Do changes in the interest rate have a large effect on his saving?
(d) Martin's parents bequeath him a gift of a = 10. At yf = 50 and r = 0.08 what are the effects on his consumption and saving? Are the effects consistent with the predictions in the textbook?
Winter Term, 1998, ECON-222 Sections C, D, E
Part A
1. Policies are same if assume Ricardian Equivalence holds. If R.E. fails then two policies can have different effects
2. Employment increase, output increase and real wage falls.
3. No. Other things do matter: inflation, population, distribution, debt, enviroment, etc.
4. An adverse supply shock reduces the marginal product of labor at any given levels of labor and capital. As a result, the labor demand curve shifts to the left, the real wage falls, and the full-employment level of employment decreases.
5.
6. Use growth accounting formula to solve, alpha=.25.
7. With a Keynesian consumption function, tax-cut decreases desired national savings.
A) Therefore Rw is unaffected; Id remains unchanged and CA deteriorates.
Part B.
1. a) MPN for each level of labour
| # of workers | MPn |
| 0 | - | 1 | 11 |
| 2 | 8< |
| 3 | 7 |
| 4 | 5 |
| 5 | 4 |
| 6 | 2 |
b) 3 workers
c) 5 workers
d) $105
2. a) (r+d)pk/(1-t)=400
b) A(1200-2K)=(r+d)pk/(1-t)
c) At A=0.8, K=350
d) Net investment 400-250=150
3. A) The current account deficit is 2.
B) r=.05 and Cd = 25
C) No changes in government savings. Private savings increase, current account balance improves.
4. (a) C=36.89, S=13.11
(b) C=33.61, S=16.39
(c) C=33.77, S=16.23 : changes in r have little effect on S (subst and income effects)
(d) C=37.22, S=12.73 : C inrease and S falls (consistent with textbook predictions)