# Intermediate Macroeconomics

1. Define  exogenous  and  endogenous  variables.  Give  an  example  of  each  within

a  model  of  your  choice.     2. Write  down  the  national  income  accounting  (NIA)  identity.  Why  is  it  called  an

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identity?   Now   identify   and   quantify   the   impacts   (if   any)   of   the   following   events  on  GDP  (Y)  and  other  components  of  NIA  identity:

a. You  buy  a  watch  worth  \$2000  from  an  antique  shop.   b. In  2014,  Riverside  Motors   imports  a   Jaguar  car   from  UK  worth  \$50,000

and  fails  to  sell  it  in  the  current  year.   c. You  pay  a  rent  of  \$1200  per  month  for  a  house  built  in  2008.   d. You  have  decided  to  buy  the  house  you  were  renting  (refer  to  question  c)

and  have  paid  \$250,000.  Now  you  are  the  owner  of  this  house.  Hint:  Use   both  c  and  d  to  answer.

3. Assume  that  an  economy  produces  only  two  goods.  Show  how  GDP  deflator   calculated  based  on  these  two  goods  can  be  interpreted  as  a  sum  of  weighted   prices.

4. Suppose   that   an   economy   produces   only   three   goods:   1,   2   and   3.   Use   the   following  table  to  find  the  inflation  rates  from  year  1  to  2.  Assume  Year  1  is   the  base  year.

P1  (\$)   Q1   P2    (\$)   Q2   P3    (\$)   Q3   Year  1   5   20   10   20   15   30   Year  2   15   25   20   30   20   30

5. What  type  of  goods  is  typically  included  in  GDP  deflator  but  not  in  CPI?  Also,   what  type  of  goods  is  typically  included  in  CPI  but  not  in  GDP  deflator?

6. Why  does  CPI  overstate  inflation?  What  is  the  approximate  estimation  of  this   upward  bias?

Topic  3:  Chapter  5  (M)

7. Why  is  the  theory  of  inflation  that  we  have  learnt  in  the  class  called  classical

theory?   8. During  the  recent  recession,  the  Fed  wanted  to  spur  the  economic  growth  by

pumping  money  into  the  economy.  What  action  do  you  think  the  Fed  took  to   pump  money?  Explain.

9. Give  an  example  of   a   transaction  whose  value  does  not  qualify   as   a  part  of   nominal  GDP.  Also  give  an  example  where  it  does.

10. Suppose  that  the  velocity  of  money  is  constant.  Now,  real  GDP  grows  by  5%   per  year,  the  money  stock  grows  by  14%  per  year  and  the  nominal   interest   rate  is  11%.  Calculate  the  real  interest  rate.

11. Suppose  a   country  has  a  money  demand   function   (M/P)d=  kY,  where  k   is  a   constant  parameter.  The  money  supply  grows  by  12%  per  year  and  the  real   income  grows  by  4%  per  year.

a. What  is  the  average  inflation  rate?   b. How  would  inflation  be  different  if  real  income  growth  were  higher?  Explain.   c. What  is  the  interpretation  of  k?  How  is  it  related  to  the  velocity  of  money?   d. Suppose,   instead   of   a   constant   money   demand   function,   the   velocity   of

money  in  this  economy  was  growing  steadily  because  of  financial  innovation.   How  would  that  affect  the  inflation  rate?  Explain.

12. In  each  of  the  scenarios,  explain  and  categorize  the  cost  of  inflation.     a. Because  inflation  has  risen,  the  L.L  Bean  Company  decides  to  issue  a  new

catalog  quarterly  rather  than  monthly.   b. Grandma   buys   an   annuity   for   \$100,000   from   an   insurance   company,

which  promises   to  pay  her   \$10,000   a   year   for   the   rest   of   her   life.  After   buying   it,   she   is   surprised   that  high   inflation   triples   the  price   level  over   the  next  few  years.

c. Maria  lives  in  an  economy  with  hyperinflation.  Each  day  after  being  paid,   she   runs   to   store   as   quickly   as   possible   so   she   can   spend   her   money   before  it  loses  value.

d. Your  father  tells  you  that  when  he  was  your  age,  he  worked  for  only  \$3  an   hour.  He  suggests  that  you  are  lucky  to  have  a  job  that  pays  \$7  an  hour.

13. Define   seigniorage.   Suppose   Fed   prints   one   thousand   \$10   bills   incurring   a   cost  of  \$0.5/bill.  What  is  the  seigniorage  here?

14. Define  inflation  tax.   15.  What  is  the  relationship  between  money  demand  and  nominal  interest  rate?     16. We  know  that  in  equilibrium  the  following  holds:

Explain  what   happens   to   current   inflation   (i.e.   P)   if   Fed   announces   now   to                   decrease  money  supply  next  year.

( , )π= +M L r Y P

E

17. What  is  hyperinflation?  What  causes  hyperinflation?   18. Define  classical  dichotomy.     19. Using  the  graph  for  labor  market,  show  how  moderate  inflation  can  be  a  good

thing?   20.  Read  the  case  study  “Hyperinflation  in  Zimbabwe”.  Now  explain  briefly  in

your  own  words  what  caused   the  hyperinflation   in  Zimbabwe  and  how  did   they  finally  manage  to  get  out  of  it.

Topic  4:  Chapter  7  (M)     21. Write   down   the   steady-­‐state   condition   for   labor  market   and   interpret   it   in

words.   22. Define  natural  rate  of  unemployment.  Derive  a  relationship  between  natural

rate  of  unemployment,  job  separation  rate  and  job  finding  rate.  What  value  of   job  finding  rate  would  render  a  zero  rate  of  unemployment?

23. If  job  separation  rate  goes  up  by  3%  and  job  finding  rate  goes  up  by  2%,  what   happens  to  steady-­‐state  unemployment  rate?

24. Explain   the   pros   and   cons   of   unemployment   benefit.  What   is   its   impact   on   European  countries’  unemployment?

25. Some   economists   argue   that  minimum  wage   fails   to   target   the   appropriate   working   poor.   Explain   graphically   how   minimum   wage   is   non-­‐binding   for   middle-­‐aged   workers   but   binding   for   teenage   workers.   What   alternative   policy  do  the  economists  suggest?

26. Explain  briefly  what  efficiency  wage  is  and  why  firms  pay  efficiency  wage.     27. Suppose   there   are   only   two   sectors   in   the   economy:   manufacturing   and

services.  40%  of  the  manufacturing  employees  are  union  members  whereas   the  number  is  15%  for  services.  Which  sector  do  you  think  has  higher  wage   ratio   (100x   union  wage/nonunion  wage)?  Why?   Also   explain  which   sector   you  think  might  have  higher  unemployment.

28. Read  the  case-­‐study  “The  Increase   in  US  Long-­‐Term  Unemployment  and   the  Debate  Over  Unemployment   Insurance”.  What  are  the  two  opposing   views   of   Economists   Robert   Barro   and   Paul   Krugman   about   the   reason   behind  the  unprecedented  spike  in  the  median  duration  of  US  unemployment   during  the  recent  financial  crisis?

Topic  #5  (A  Model  of  Production-­‐  Jones)

29. How  would  you  describe  returns  to  scale  in  the  following  production   function,  where  R  is  natural  resources,  L  is  Labor  and  K  is  Capital?  f(R,   L,K)=AL^(1/2)K^(1/4)R^(1/4)

30. How  would  you  describe  returns  to  L  and  K  separately  in  the  following   production  function?    f(L,K)=AL^(1/2)K^(1/4)

31. How  would  you  describe  returns  to  scale  in  the  following  production   function,  where  L  is  Labor  and  K  is  Capital?  f(L,K)=AL^(1/2)K^(1/4)

32. Write  out  the  main  equation  that  we  use  to  explain  differences  in  wealth

between  countries.  In  general,  how  well  does  this  equation  explain  the   differences  we  see  across  countries  GDP  in  the  world?

33. Please  answer  the  following  questions  about  the  effect  of  changes  in  the   variables  in  the  Cobb-­‐Douglas  model  of  output.

a. What  is  the  effect  of  doubling  K/L  on  Y/L?

b. What  is  the  effect  of  doubling  A  on  Y/L?

c. Suppose  that  there  are  two  countries  with  equal  Y/L.  Country  I  has   K/L  that  is  20%  larger  than  Country  II.  What  does  this  tell  you  about  A   in  country  I  versus  country  II.

d. Explain  how  well  our  model  predicts  GDP  per  capita  across  the  world   (if  we  hold  A  constant)

e. Explain  two  reasons  that  A  might  very  across  countries

34. Derive  the  labor  share  of  income  using  our  standard  Cobb-­‐Douglas   production  function.

35. Derive  the  marginal  product  of  capital  (K)  and  labor  (K)  for  the  following   functions:

(a) Z  =  AKL     (b) Z  =  (AK)/L   (c) Z  =  AK1/3L2/3   (d) Z  =  (AKL)1/2   (e) Z  =  (AK/L)2/3

Topic  #6  (Solow  Growth  Model-­‐Jones)

36. What   is   the   basic   difference   between   our   simple   model   of   production   introduced  in  topic  5  and  the  Solow  growth  model?

37.  Write   down   the   five   key   equations   which   constitute   the   Solow   growth   model.

38. Solve  the  Solow  growth  model.  In  other  words,  show  that:                              ∆𝐾!!! = 𝑠𝐴𝐾!

!/!𝐿!/! − 𝑑𝐾!     39. Write  down  the  condition  which  characterizes  the  steady-­‐state  of  the  Solow

growth  model.  What  happens  when  capital  is  above  the  steady-­‐state  level?       40. Drawing  Solow  diagram,  identify  the  steady-­‐state  level  of  capital  and  output.