The Fed is considering two alternative monetary policies: • holding the money supply constant and letting the interest rate adjust, or • adjusting the money supply to hold the interest rate constant. In the IS–LM model, which policy will better stabilize output under the following conditions? Explain your answer. a. All shocks to the economy arise from exogenous changes in the demand for goods and services. b. All shocks to the economy arise from exogenous changes in the demand for money.
> List three macroeconomic issues that have been in the news lately.
> Explain the difference between debt finance and equity finance.
> In each of the following cases, identify whether the problem is adverse selection or moral hazard, and explain your answer. How might the problem be dealt with? a. Rick has gotten a large advance to write a textbook. With the money in hand, he prefers sp
> What was unusual about U.S. fiscal policy from 1980 to 1995?
> On April 1, 1996, Taco Bell, the fast-food chain, ran a full-page ad in the New York Times with this news: “In an effort to help the national debt, Taco Bell is pleased to announce that we have agreed to purchase the Liberty Bell, one of our country’s mo
> What are the inside lag and the outside lag? Which has the longer inside lag—monetary or fiscal policy? Which has the longer outside lag? Why?
> Suppose that the tradeoff between unemployment and inflation is determined by the Phillips curve: u = un - a(π - Eπ), where u denotes the unemployment rate, un the natural rate, p the rate of inflation, and Ep the expected rate of inflation. In addition,
> Use the neoclassical theory of distribution to predict the impact on the real wage and the real rental price of capital of each of the following events: a. A wave of immigration increases the labor force. b. An earthquake destroys some of the capital sto
> In the 1970s in the United States, the inflation rate and the natural rate of unemployment both rose. Let’s use this model of time inconsistency to examine this phenomenon. Assume that policy is discretionary. a. In the model as developed so far, what ha
> In the neoclassical model of business fixed investment, under what conditions will firms find it profitable to add to their capital stock?
> Use the neoclassical model of investment to explain the impact of each of the following on the rental price of capital, the cost of capital, and investment. a. Anti-inflationary monetary policy raises the real interest rate. b. An earthquake destroys par
> What were Keynes’s three conjectures about the consumption function?
> The chapter uses the Fisher model to discuss a change in the interest rate for a consumer who saves some of his first-period income. Suppose, instead, that the consumer is a borrower. How does that alter the analysis? Discuss the income and substitution
> On a carefully labeled graph, draw the dynamic aggregate supply curve. Explain why it has the slope it has.
> Derive the long-run equilibrium for the dynamic AD–AS model. Assume there are no shocks to demand or supply (Ɛt = yt = 0) and inflation has stabilized (πt = πt-1), and then use the five equations in Tab
> Explain the two theories of aggregate supply. On what market imperfection does each theory rely? What do the theories have in common?
> In the sticky-price model, describe the aggregate supply curve in the following special cases. How do these cases compare to the short-run aggregate supply curve we discussed in Chapter 10? a. All firms have sticky prices (s = 1). b. The desired price do
> Let’s consider some more special cases of the mother of all models. Starting with this comprehensive model, what extra assumptions would you need to yield each of the following specialized models? a. The model of the classical large open economy in the a
> List the two things that GDP measures. How can GDP measure two things at once?
> In the Mundell–Fleming model with floating exchange rates, explain what happens to aggregate income, the exchange rate, and the trade balance when taxes are raised. What would happen if exchange rates were fixed rather than floating?
> Use the Mundell–Fleming model to predict what would happen to aggregate income, the exchange rate, and the trade balance under both floating and fixed exchange rates in response to each of the following shocks. Be sure to include an appropriate graph in
> Macroeconomic data do not show a strong correlation between investment and interest rates. Let’s examine why this might be so. Use our model in which the interest rate adjusts to equilibrate the supply of loanable funds (which is upward sloping) and the
> Suppose that consumption depends on the interest rate. How, if at all, does this alter the conclusions reached in the chapter about the impact of an increase in government purchases on investment, consumption, national saving, and the interest rate?
> When the government subsidizes investment, such as with an investment tax credit, the subsidy often applies to only some types of investment. This question asks you to consider the effect of such a change. Suppose there are two types of investment in the
> Consider whether each of the following events is likely to increase or decrease real GDP. In each case, do you think the well-being of the average person in society most likely changes in the same direction as real GDP? Why or why not? a. A hurricane in
> You read on a financial Web site that the nominal interest rate is 12 percent per year in Canada and 8 percent per year in the United States. Suppose that international capital flows equalize the real interest rates in the two countries and that purchasi
> Suppose that the government increases taxes and government purchases by equal amounts. What happens to the interest rate and investment in response to this balanced-budget change? Explain how your answer depends on the marginal propensity to consume.
> In a speech that Senator Robert Kennedy gave when he was running for president in 1968, he said the following about GDP: [It] does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include th
> This problem asks you to analyze the IS–LM model algebraically. Suppose consumption is a linear function of disposable income: C(Y - T ) = a + b(Y - T ), where a> 0 and 0 < b < 1. The parameter b is the marginal propensity to consume, and the parameter a
> “Traveling in Mexico is much cheaper now than it was ten years ago,” says a friend. “Ten years ago, a dollar bought 10 pesos; this year, a dollar buys 15 pesos.” Is your friend right
> Consider an economy described as follows: Y= C + I+ G. Y = 8,000. G = 2,500. T = 2,000. C = 1000 + 2/3(Y-T ). I = 1,200 - 100r. a. In this economy, compute private saving, public saving, and national saving. b. Find the equilibrium interest rate. c. Now
> Imagine that you run the central bank in a large open economy with a floating exchange rate. Your goal is to stabilize income, and you adjust the money supply accordingly. Under your policy, what happens to the money supply, the interest rate, the exchan
> An economy has 100 people divided among the following groups: 25 have full-time jobs, 20 have one part-time job, 5 have two part-time jobs, 10 would like to work and are looking for jobs, 10 would like to work but are so discouraged they have given up lo
> This problem uses calculus to compare two scenarios of consumer optimization. a. Nina has the following utility function: U = ln(C1) + ln(C2) - ln(C3) She starts with wealth of $120,000, earns no additional income, and faces a zero interest rate. How m
> Use the dynamic AD–AS model to solve for inflation as a function of only lagged inflation and supply and demand shocks. (Assume target inflation is constant.) a. According to the equation you have derived, does inflation return to its target after a shoc
> Go to the Web site of the Bureau of Labor Statistics (http://www.bls.gov). For each of the past five years, find the inflation rate as measured by the consumer price index for\all items (sometimes called headline inflation) and as measured by the CPI exc
> Use the Mundell–Fleming model to answer the following questions about the state of California (a small open economy). a. What kind of exchange-rate system does California have with its major trading partners (Alabama, Alaska, Arizona, . . .)? b. If Calif
> Suppose that the demand for real money balances depends on disposable income. That is, the money demand function is M/P = L(r, Y - T ). Using the IS–LM model, discuss whether this change in the money demand function alters the following. a. The analysis
> In any city at any time, some of the stock of usable office space is vacant. This vacant office space is unemployed capital. How would you explain this phenomenon? In particular, which approach to explaining unemployed labor applies best to unemployed ca
> Oceania is a small open economy. Suppose that a large number of foreign countries begin to subsidize investment by instituting an investment tax credit (while adjusting other taxes to hold their tax revenue constant), but Oceania does not institute such
> Jimmy Paul Miller starts his own bank, called JPM. As owner, Jimmy puts in $2,000 of his own money. JPM then borrows $4,000 in a long-term loan from Jimmy’s uncle, accepts $14,000 in demand deposits from his neighbors, buys $7,000 of U.S. Treasury bonds,
> Suppose that an increase in consumer confidence raises consumers’ expectations about their future income and thus increases the amount they want to consume today. This might be interpreted as an upward shift in the consumption function. How does this shi
> Explain why the aggregate demand curve slopes downward.
> Abby consumes only apples. In year 1, red apples cost $1 each, green apples cost $2 each, and Abby buys 10 red apples. In year 2, red apples cost $2, green apples cost $1, and Abby buys 10 green apples. a. Compute a consumer price index for apples for ea
> Why might the level of government debt affect the government’s incentives regarding money creation?
> Consider two savings accounts that pay the same interest rate. One account lets you take your money out on demand. The second requires that you give 30-day advance notification before withdrawals. a. Which account would you prefer? Why? b. Can you imagin
> Suppose that people’s expectations of inflation are subject to random shocks. That is, instead of being merely adaptive, expected inflation in period t, as seen in period t - 1, is Et-1πt =π t-1 + nt 1, where ht21 is a random shock. This shock is normall
> Some economists believe that taxes have an important effect on the labor supply. They argue that higher taxes cause people to want to work less and that lower taxes cause them to want to work more. Consider how this effect alters the macroeconomic analys
> Suppose that the price level relevant for money demand includes the price of imported goods and that the price of imported goods depends on the exchange rate. That is, the money market is described by M/P = L(r, Y ), where P = λPd + (1 -λ)Pf/e. Her
> Choose two countries that interest you—one rich and one poor. What is the income per person in each country? Find some data on country characteristics that might help explain the difference in income: investment rates, population growth rates, educationa
> Consider how unemployment would affect the Solow growth model. Suppose that output is produced according to the production function Y= K a[(1 - u)L]1-a, where K is capital, L is the labor force, and u is the natural rate of unemployment. The national sav
> When workers’ wages rise, their decision about how much time to spend working is affected in two conflicting ways—as you may have learned in courses in microeconomics. The income effect is the impulse to work less, because greater incomes mean workers ca
> According to the IS–LM model, what happens in the short run to the interest rate, income, consumption, and investment under the following circumstances? Be sure your answer includes an appropriate graph. a. The central bank increases the money supply. b.
> Suppose China exports TVs and uses the yuan as its currency, whereas Russia exports vodka and uses the ruble. China has a stable money supply and slow, steady technological progress in TV production, while Russia has very rapid growth in the money supply
> Some economic historians have noted that during the period of the gold standard, gold discoveries were most likely to occur after a long deflation. (The discoveries of 1896 are an example.) Why might this be true?
> Give an example of a bank balance sheet with a leverage ratio of 20. If the value of the bank’s assets rises by 2 percent, what happens to the value of the owners’ equity in this bank? How large a decline in the value of bank assets would it take to redu
> Explain what happens to consumption, investment, and the interest rate when the government increases taxes.
> The government raises taxes by $100 billion. If the marginal propensity to consume is 0.6, what happens to the following? Do they rise or fall? By what amounts? a. Public saving b. Private saving c. National saving d. Investment
> Consider an economy that produces and consumes hot dogs and hamburgers. In the following table are data for two different years. a. Using 2010 as the base year, compute the following statistics for each year: nominal GDP, real GDP, the implicit pric
> What are the pros and cons of using public funds to prop up a financial system in crisis?
> Give three reasons that a budget deficit might be a good policy choice.
> U.S. tax laws encourage investment in housing (such as through the deductibility of mortgage interest for purposes of computing taxable income) and discourage investment in business capital (such as through the corporate income tax). What are the long-ru
> A Case Study in the chapter indicates that the elderly do not dissave as much as the life-cycle model predicts. a. Describe the two possible explanations for this phenomenon. b. One study found that the elderly who do not have children dissave at about t
> Use the Keynesian cross to explain why fiscal policy has a multiplied effect on national income.
> The text assumes that the natural rate of interest r is a constant parameter. Suppose instead that it varies over time, so now it has to be written as rt. a. How would this change affect the equations for dynamic aggregate demand and dynamic aggregate s
> Suppose that an economy has the Phillips curve π = π-1 - 0.5(u - un) and that the natural rate of unemployment is given by an average of the past two years’ unemployment: un = 0.5(u-1 + u-2). a. Why might the natural rate of unemployment depend on recen
> Suppose that money demand depends on disposable income, so that the equation for the money market becomes M/P = L(r, Y - T ). Analyze the short-run impact of a tax cut in a small open economy on the exchange rate and income under both floating and fixed
> Use the IS–LM diagram to describe both the short-run effects and the long-run effects of the following changes on national income, the interest rate, the price level, consumption, investment, and real money balances. a. An increase in the money supply b.
> This question asks you to analyze in more detail the two-sector endogenous growth model presented in the text. a. Rewrite the production function for manufactured goods in terms of output per effective worker and capital per effective worker. b. In this
> In the Solow model, population growth leads to steady-state growth in total output, but not in output per worker. Do you think this would still be true if the production function exhibited increasing or decreasing r turns to scale? Explain. (For the defi
> Consider an economy with two sectors: manufacturing and services. Demand for labor in manufacturing and services are described by these equations: Lm = 200 -6W m Ls = 100 - 4Ws where L is labor (in number of workers), W is the wage (in dollars), and the
> Here is a table similar to Table 6-2 (but in alphabetical order) for the currencies of four imaginary nations. Use the theory of purchasing-power parity to fill in the blanks with a number or “NA” if the figure is not
> Define the terms real variable and nominal variable, and give an example of each.
> In each of the following scenarios, explain and categorize the cost of inflation. a. Because inflation has risen, the J. Crew clothing company decides to issue a new catalog monthly rather than quarterly. b. Grandpa buys an annuity for $100,000 from an i
> Use the Keynesian cross model to predict the impact on equilibrium GDP of the following. In each case, state the direction of the change and give a formula for the size of the impact. a. An increase in government purchases b. An increase in taxes c. Equa
> To increase tax revenue, the U.S. government in 1932 imposed a 2-cent tax on checks written on bank account deposits. (In today’s dollars, this tax would amount to about 34 cents per check.) a. How do you think the check tax affected the currency–deposit
> What makes the demand for the economy’s output of goods and services equal the supply?
> (This problem requires the use of calculus.) Consider a Cobb–Douglas production function with three inputs. K is capital (the number of machines), L is labor (the number of workers), and H is human capital (the number of college degrees among the workers
> Tina is the sole owner of Tina’s Lawn Mowing, Incorporated (TLM). In one year, TLM collects $1,000,000 from customers to mow their lawns. TLM’s equipment depreciates in value by $125,000. TLM pays $600,000 to its workers, who pay $140,000 in taxes on thi
> What does it mean for a central bank to act as lender of last resort?
> Do you find the traditional or the Ricardian view of government debt more credible? Why?
> List three policy rules that the Fed might follow. Which of these would you advocate? Why?
> The United States experienced a large increase in the number of births in the 1950s. People in this baby-boom generation reached adulthood and started forming their own households in the 1970s. a. Use the model of residential investment to predict the im
> Give an example in which someone might exhibit time-inconsistent preferences.
> Demographers predict that the fraction of the population that is elderly will increase over the next 20 years. What does the life-cycle model predict for the influence of this demographic change on the national saving rate?
> When real GDP declines during a recession, what typically happens to consumption, investment, and the unemployment rate?
> Suppose a central bank does not satisfy the Taylor principle; in particular, assume that up is slightly less than zero, so the nominal interest rate rises less than one-for-one with inflation. Use a graph similar to figure 15-13 to analyze the impact of
> Explain two ways in which a recession might raise the natural rate of unemployment.
> Assume that people have rational expectations and that the economy is described by the sticky price model. Explain why each of the following propositions is true. a. Only unanticipated changes in the money supply affect real GDP. Changes in the money sup
> Suppose that higher income implies higher imports and thus lower net exports. That is, the net-exports function is NX = NX(e, Y ). Examine the effects in a small open economy of a fiscal expansion on income and the trade balance under the following excha
> Monetary policy and fiscal policy often change at the same time. a. Suppose that the government wants to raise investment but keep output constant. In the IS–LM model, what mix of monetary and fiscal policy will achieve this goal? b. In the early 1980s,
> The following equations describe an economy. Y + C + I + G. C = 50 + 0.75 (Y - T ). I = 150 - 10 r. (M/P)d = Y + 50r. G = 250. T = 200. M = 3,000. P = 4 a. Identify each of the variables and briefly explain their meaning. b. From the above list, use the
> How does endogenous growth theory explain persistent growth without the assumption of exogenous technological progress? How does this differ from the Solow model?
> The amount of education the typical person receives varies substantially among countries. Suppose you were to compare a country with a highly educated labor force and a country with a less educated labor force. Assume that education affects only the leve
> Many demographers predict that the United States will have zero population growth in the coming decades, in contrast to the historical average population growth of about 1 percent per year. Use the Solow model to forecast the effect of this slowdown in p
> Suppose that a country experiences a reduction in productivity—that is, an adverse shock to the production function. a. What happens to the labor demand curve? b. How would this change in productivity affect the labor market—that is, employment, unemploy
> An economy begins in long-run equilibrium, and then a change in government regulations allows banks to start paying interest on checking accounts. Recall that the money stock is the sum of currency and demand deposits, including checking accounts, so thi
> The president is considering placing a tariff on the import of Japanese luxury cars. Using the model presented in this chapter, discuss the economics and politics of such a policy. In particular, how would the policy affect the U.S. trade deficit? How wo
> Explain the roles of monetary and fiscal policy in causing and ending hyperinflations.
> During World War II, both Germany and England had plans for a paper weapon: they each printed the other’s currency, with the intention of dropping large quantities by airplane. Why might this have been an effective weapon?
