# Intermediate Macroeconomics

QUESTION 1:

Consider a country that is characterized by the following production function:

Y= 5K.5 L.5. Assume that the rate of depreciation as well as the rate of saving are each

.10. Also assume that there is no technological progress nor population growth.

a. What is the steady state level of capital per worker?

b. What is the steady state level of output per worker?

c. Suppose that the savings rate remains at .10 while the rate of depreciation increases to .20. What now happens to steady state level of capital per worker and output per worker?

QUESTION 2:

Explain why the Lucas aggregate supply curve is steeper than the New Keynesian aggregate supply curve.

QUESTION 3:

Suppose that the government of a country increases fiscal spending. According to the real business cycle theory, what will be the impact on the economy due to this change in government spending?

QUESTION 4:

The production function of a country X is given by: y = 150n - .5n2

The demand for labor is given by: nd = 300 - 2.5 (W/P).

The supply of labor is given by: ns = 200 + 2.5 (W/P).

The expected price level is 2.

a. What is the equation of New Keynesian Aggregate Supply curve?

b. If the labor market had been of the New Classical model, what would the equation of the Lucas Aggregate Supply curve be?

QUESTION 5:

What are the shortcomings of Statistics Canada's measurement of the unemployment rate?

QUESTION 6:

Define the natural rate of unemployment. Discuss the factors that determine the natural rate of unemployment.

QUESTON 7:

What is meant by the concept of the expected inflation rate? How does the expected inflation rate influence the actual inflation rate?

QUESTION 8:

What are the key assumptions of the quantity theory of money? Assume that money supply has increased by 5%, real output has increased by 5%, and there has been no change in the velocity of money. What will be the rate of inflation?

QUESTION 9:

Use an appropriate diagram to show the impact of a favorable oil shock on output and price level.

QUESTION 10:

Is it possible to lower the inflation rate without increasing unemployment above the natural rate? Explain your answer.

QUESTION 11:

An economy has the following short run aggregate supply and aggregate demand relations:

ys = -2000 + 50 P

yd = 4000 - 50P

Calculate the following:

a. Real GDP and price level.

b. If the money supply increases by 10% and it is anticipated, what is the new real GDP and price level?

c. What is new short run aggregate supply curve? Why has it changed?

#### Solution Preview

1. To find the steady-state value of the country, we solve delta k = s f(k)- dk derived from setting the motion of capital equation to zero, solving for k and then solving for y.

sf(k*) = dk*

Using the values given for s and d:

.10 f(k*) = .10k*

the per worker production function is Y/L = 5K^.5 L^.5/L = 5 (K/L)^.5

Then substitute y = Y/L and k = K/L to get

y = f(k) = 5 k^.5

Thus, .5 k*^.5 = .10 k*

5 =k*/k*^.5 = k*^.5

Solve to get: k* = 25 and y* = 5k*^.5= 25

If depreciation increases to .2, we must change the equation sf(k*) = dk* to .10 f(k*) = .20k*.

Then,

.5 k*^.5 = .20 k*

2.5 k*/k*^.5 = k*^.5

This yields a new k* level of 6.25 and a new y* level of 12.5.

2. An aggregate supply curve represents the relationship between real production and the price level. The Lucas aggregate supply curve assumes that producers cannot see the aggregate price level; as a result, they make their production decisions without full knowledge of the relative prices they will receive for their goods. Thus they confuse aggregate price movements because of general inflation (in which case no response is necessary) with a relative price changes (in which case individual output should rise). This generates an upward-sloping aggregate supply curve. The New Keynesian AS curve is reverse-L shaped, with the vertical and horizontal segments having positive slopes and connected by a rounded corner. The graph's shape indicates that a decline in demand leads to a decline in real production, primarily because prices remain constant. The vertical segment is a recognition that the total quantities of resources are fixed and that total production is ultimately limited, which results in full employment.

3. According to real business cycle theory, the business cycle is caused by random fluctuations in productivity. Unlike other leading theories of the business cycle, it sees recessions and periods of economic growth as the efficient response of output to exogenous variables. That is, RBC theorists argue that at any point in time, the level of national output necessarily maximizes utility, and government should therefore not intervene through fiscal or monetary policy. Thus, increasing fiscal spending is a ...

#### Solution Summary

Aggregate supply, steady state level of output per worker and capital per worker, oil supply shock