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Principles of Macroeconomics - DOC by we9mj6AB

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									Principles of Macroeconomics                                                                  Dr. Hartmann
Sprig 2012                                                                                    Worksheet #4

Due: TBA


1.   Review: Answer the following questions in terms of its impact on the U.S. economy. Assume marginal
     propensity to consume in the U.S. equals .9. Fill in columns 2-4.


Given change in     Direction of shift or             Direction of shift or movement      Size of shift/
Autonomous AE       movement in AE (Circle one.)      in AD (Circle one.)                 movement of AD ;
                                                                                          Size of Δ in GDP
Decrease of $5b     Shift Up AE /Shift Down AE        Shift AD Right/ Shift AD Left/      $         ;$
in C b/c drop in    /Movement Along AE to left/       Movement Along AD to left/
U.S. real GDP       Movement Along AE to Right        Movement Along AD to Right
Decrease of $5b     Shift Up AE /Shift Down AE        Shift AD Right/ Shift AD Left/      $        ;$
in C b/c of drop    /Movement Along AE to left/       Movement Along AD to left/
in U.S. consumer    Movement Along AE to Right        Movement Along AD to Right
expectations
Increase of $6b     Shift Up AE /Shift Down AE        Shift AD Right/ Shift AD Left/      $        ;$
in S b/c of drop    /Movement Along AE to left/       Movement Along AD to left/
in U.S. consumer    Movement Along AE to Right        Movement Along AD to Right
expectations
Increase of $5b     Shift Up AE /Shift Down AE        Shift AD Right/ Shift AD Left/      $        ;$
in NX b/c of rise   /Movement Along AE to left/       Movement Along AD to left/
in quality per $    Movement Along AE to Right        Movement Along AD to Right
of Amer. goods
Increase of $7b     Shift Up AE /Shift Down AE        Shift AD Right/ Shift AD Left/      $        ;$
in NX b/c the       /Movement Along AE to left/       Movement Along AD to left/
U.S. price level    Movement Along AE to Right        Movement Along AD to Right
drops
Increase of $8b     Shift Up AE /Shift Down AE        Shift AD Right/ Shift AD Left/      $        ;$
in NX because       /Movement Along AE to left/       Movement Along AD to left/
foreign price       Movement Along AE to Right        Movement Along AD to Right
level rise
Decrease of $10b    Shift Up AE /Shift Down AE        Shift AD Right/ Shift AD Left/      $        ;$
in NX because of    /Movement Along AE to left/       Movement Along AD to left/
drop in foreign     Movement Along AE to Right        Movement Along AD to Right
RGDP


2.   In 1993, Congress failed to pass President Bill Clinton's $16 billion economic stimulus package intended to
     create jobs. A major criticism was that this new spending was not matched by tax increases.

         a.   Assume the U.S. economy is below potential output and Congress has passed a law that requires that
              an increase in spending of $16 billion must be matched or balanced by an equal increase in taxes. The
              MPC is .75 and real GDP must be increased by $20 billion to reach potential output (i.e., U = NRU).
              What impact will the increases in government spending and taxes by $16 billion each have on RGDP?
              Will the economy reach potential? Show work on separate sheet.

         b.    Instead assume the government decides to increase government spending by $16 billion and
              simultaneously reduce taxes by $16 billion. What impact will this have on aggregate output, i.e., real
              gdp? Will they reach potential output? Show work on separate sheet.
3.   In the mid 1980s, the leaders of the G7 1 countries agreed to lower the value of the U.S. dollar relative to foreign
     currencies. This made American goods relatively less expensive and Japanese goods, for instance, relatively
     more expensive than before.

a) How will the changes in relative prices affect real GDP for the U.S. in the short run, the long run, and the long-
   long run? Use NX, AE, AD, SRAS, and LRAS curves to demonstrate your point. Four graphs should be
   provided in your analysis to be considered complete. [Assume a) consumer purchases are sensitive to
   relative price changes, b) the government does not intervene and help out the market by raising T and/or
   lowering G+R, and 3) the Federal Reserve does not intervene and use monetary policy to counter the
   unexpected change in AD.] Hint: Use cookie cutter approach to guide you through the steps.

Step 1.                                               Step 2.                                               Step 3.




Step 4 – 7




b) Fill out the following table based on your graphical analysis for part (a).

                                           Real GDP (Circle One.)                         Price Level (Circle One)
Short Run Impact                 Rise        Fall  Returns to P.O.                              Rise       Fall
Long Run Impact                  Rise        Fall  Returns to P.O.                              Rise       Fall
                                                                                          Returns To Original PL
Long-long run Impact*            Rise         Fall      Remain The Same                    --------------------------

     * Hint for the long-long run analysis: Just because foreigners are buying more American products does that
     mean the U.S.’s potential output – maximum sustainable output – has increased?



1
  A group of countries and a loose organization of national economic and monetary authorities committed to working out economic and currency
exchange rate issues. In the mid 1980s, the countries included France, Germany, Italy, United Kingdom, U.S., Canada, and Japan.
4.   Distinguish between discretionary fiscal policy and automatic stabilizers. Provide some examples of automatic
     stabilizers. Explain the impact of automatic stabilizers on disposable income as the economy moves through
     the business cycle. (See chapter 12 pages 254 and 262-263.) Place write-up on separate sheet.

5.   Application: provide one example of a government legislation that would shift the LRAS and one type of a
     government legislation that would not shift LRAS. [Try to be creative and explain why shifting or not shifting
     potential output.] Place write-up on separate sheet.


--------------------------------------------------------------------------------------------------------------------------
Cookie cutter approach for chapter 11 policy problems: (hwk question #3 & optional problems #1-3

     Step 1: Identify which AE component is changing (C, I, G, or NX) and how that component is changing (shift
     or move along curve).

     Step 2: Shift AE curve in appropriate direction.

     Step 3: Once you have this information, you know if you should shift or move along the AD curve.

     Step 4: Draw your AD, SRAS, and LRAS curves. Assume you are in long run equilibrium and label the point
     with the letter A. Also assume that the expected price level is 100.

     Step 5: Shift the AD in the appropriate direction given your analysis in step 3. Label the new equilibrium with
     the letter B. Now you have derived the short-run impact on price level and real gdp.

     Step 6: Move the appropriate curves to get back to long run equilibrium. Label the new equilibrium with the
     letter C. Now you have derived the long-run impact on price level and real gdp.

     Step 7: Finally, determine if one shifts the LRAS in the long-long run. Now you have derived
     the long-long run impact on real gdp.
--------------------------------------------------------------------------------------------------------------------------

Optional Problems:

1.   Foot-and-Mouth disease spread though out the United Kingdom and Ireland. In fear, exports of meat-related
     products dropped as well tourism, particularly tourism by foreigners. In Britain alone, almost 3.8 million sheep,
     cows and pigs were slaughtered to try to contain the disease. Foot-and-mouth disease was harmless to humans
     but diminished the animal’s productivity (i.e., reduced the rate of weight gain) and therefore made it more
     costly to raise animals. Explain how the outbreak of this disease might have affected equilibrium real GDP for
     the U.K. in the short run, in the long run, and in the long-long run. Use NX, AE, AD, SRAS and LRAS curves
     to demonstrate your argument.

2.   Determine whether each of the following changes would make fiscal policy more effective or less effective in
     countering a recession. Provide a brief statement of why.
         a. Decrease in the MPC
         b. Shorter lags in the effect of fiscal policy
         c. More accurate measurement of NRU

3.   Redo homework problem #3 assuming that the Federal Reserve intervenes to combat the unexpected change in
     AD. Redo the problem assuming the Federal Government will intervene.

4.   Explain the long-long run effect (if any) on potential output for the following events.
              a. Increased job opportunities overseas have caused many people to leave the United States and not
                   immigrate to the United States. Explain what the impact (if any) this has on US’s potential output.
              b. Quote from founder of Books for Africa: “We’re in the preventive business. If there is a famine in
                   Somalia and someone sends money and food, that’s very important. But wouldn’t it be great to
                   prevent the famine before it starts? That happens through education and economic development.”
5.   Explain the long-long run effect (if any) on potential output for the following events.

         a.   Rising health care expenses is a concern for all U.S. businesses. Costs are rising 10-15% a year and no
              one expects this increase to slow down in the future. Explain what the impact (if any) is on US’s
              potential output. (Or any of the scenarios listed on the sheet titled “AE graphs.”

         b.   On September 28th 2005, the former president of Burundi spoke to the UST community about his
              country. In his lecture, he identified improving the educational system as the most important thing to
              help rebuild Burundi. Explain in terms of impact on Burundi’s potential output.

         c.   In January of 2006, a group of UST engineering students designed a device to shred and dry a
              Caribbean fruit called breadfruit. Fresh breadfruit only lasts 48 hours before it begins to rot and
              because of the high humidity in the Caribbean, it takes a long time for the fruit to dry and most of it
              goes to waste. The device will increase the speed of shredding and drying and ultimately reduce
              waste. Explain what the impact (if any) is on Haiti’s potential output. (Assume for the sake of this
              problem that breadfruit is a substantial part of the country’s GDP.)

         d.   In the spring of 2006, France passed a law that allows employers to fire new workers without cause in
              their first two years of employment. (Note that in the U.S. most jobs can be terminated without cause.)
              Suppose this law leads to additional laws that allow firms to fire other employees (i.e., make the labor
              market more flexible). Explain what the impact (if any) this may have on France’s potential output.
              (Hint: see lecture notes on the European labor market when discussing unemployment.)

         e.   In 2006, the Chinese government passed legislation, such as clearer copyright laws, that defined
              property rights more clearly and made contracts more enforceable. Explain what the impact (if any)
              this had on China’s potential output.

         f.   Norm Colman, U.S. Senator, in his letter to the Aquin (2/23/07) announced that the president has
              proposed to raise the maximum award for a Pell Grant to $4600. Assume Congress approves the
              award increase. Explain what impact (if any) this will have on the U.S.’s potential output if this leads
              to more people attending college and becoming more educated.

         g.   Finland, like many countries, tax imported agricultural products to protect its agricultural sector.
              Explain what the impact (if any) is on Finland’s potential output.

         h.   As part of the 2009 stimulus package, Congress allocated $46billion toward transportation and mass
              transit projects. Suppose this decreases the amount of time it takes to ship goods across the nation.
              Explain how the upgrading of our transportation system affects (if at all) US’s potential output.

         i.    On the midterm, I asked a question about American Jobs Act, “…a plan to create work across the
              country, entrepreneurship was a key component of the proposed legislation. The aim was to accelerate
              the pace of innovation and the success of entrepreneurs … In his recent State of the Union address,
              President Obama again stressed the importance of innovation and financial support for entrepreneurs
              for long-term job growth.” (Source: Financial Times 2/6/12) Now you can explain how entrepreneurs
              affect (if at all) US’s potential output.

         j.   On the midterm: A new OECD report, Equity and Quality in Education: Supporting Disadvantaged
              Students and Schools, says that helping those in need would reduce school failure, boost economic
              growth and contribute to a fairer society. Today, many students lack basic skills, as measured by PISA,
              and one in five students on average across the OECD drops out of the education system before
              finishing upper secondary [i.e., high school]. Dropout rates range from 2% in Korea to 58% in Turkey
              for the 25-34 years-old. [See figure below.] Leaving school this early means that students lack the
              skills they need in today’s job market, says the OECD. Explain how will lack of education affect (if at
              all) a country’s potential output.

								
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