Principles of Macroeconomics Hartmann
Spring 2017 Worksheet 3
Due: TBA
You may answer questions 1 and 2 on this sheet, but answer the remaining questions on a separate sheet.
1. For each expenditure curve, C, I, G, (X-M), and S, identify factors that shift each curve. Also, identify the change in what factor moves one along these curves. Hint: The factors that shift C also shift S. Why? If you are not consuming you must be saving.
AE component / Change in what factor moves one along this expenditure curve?Consumption Expenditures
Investment Expenditures
Government Expenditures
Net Exports Expenditures
Savings Expenditures
AE component / Identify (at least) two factors that shift this expenditure curve
Consumption Expenditures / ·
·
Investment Expenditures / ·
·
Government Expenditures / ·
·
Net Exports Expenditures / ·
·
Savings Expenditures / ·
·
2. Assume MPC = .9 and thus the simple spending multiplier equals 10. Fill in columns 2 &3.
Given change in / Direction of shift or / Size of shift/ movement of theAutonomous AE / movement in AE function (circle one) / AE function; Size of D in GDP
increase of $4b in G because of possible military action / Shift up/ Shift down/ movement along AE curve / $ ; $
increase of $8b in NX because U.S. price level fell / Shift up/ Shift down/ movement along AE curve / $ ; $
decrease of $5b in C because the U.S. price level rose / Shift up/ Shift down/ movement along AE curve / $ ; $
decrease of $5b in C because disposable income dropped / Shift up/ Shift down/ movement along AE curve / $ ; $
decrease of $5b in NX because trading partner’s disposable income dropped / Shift up/ Shift down/ movement along AE curve / $ ; $
3. In class, we calculated equilibrium real gdp for a given price level for a very simple model. Now let us expand the model to allow for international trade and government spending. Suppose the following represents that economy.
AE = C + I + G + X-M
where C = 100 + .75(Y)
I = 25
G = 200
X-M = 30
Y= real GDP (i.e., aggregate income)
a) What is the MPC? MPS?
b) What is the equilibrium level of GDP? (Think about how we solved for equilibrium GDP in class. One approach was the income-expenditure approach where AE = real gdp and this can be rewritten as C+I+G+X-M = Y. If you plug in 25 for I, 200 for G, etc., and solve for Y … then you will have found equilibrium RGDP, i.e., RGDP that equates aggregate expenditures and aggregate income..)
c) Suppose the government increases its expenditures by $50 in hope of spurring economic growth.
`i. By how much does equilibrium level of GDP change?
ii. What is the new equilibrium level of GDP?
d) If G returns to $200 next year and all of the other expenditure types do not change, then what is the equilibrium level of GDP next year? (hint: the question is really as easy as you think.)
e) If G remains at $250 next year and all of the other expenditure types do not change, then what is the equilibrium level of GDP next year? (hint: the question is really as easy as you think.)
Note: In reality, the size of the multiplier for the U.S. is about 1.4.
4. Suppose you are the Governor of Minnesota and wish to host swimming trials for the Olympics in Blaine, MN. You expect that having this one time event will inject $10 million into Minnesota’s economy. The $10 million in economic activity will be generated from the purchasing of resources to build the pool (e.g., labor , concrete) and from the food, ticket, and merchandise revenue from the trials itself.
a) If the marginal propensity to save is .3 in the U.S.., how much additional income for the state will be generated from having the swimming trials held in Blaine?
b) Why may this predicted number (derived in part a) overestimate the economic impact of hosting the trials on the state economy (i.e., why may Real GDP increase by a lower amount than was calculated in part (a))? (List 3 reasons.)
c) Suppose the Olympic committee decides to hire a firm from Wisconsin to build and install the two prefabricated, above-ground pools needed for the trials. Because the pool is prefabricated, most of the labor and building materials needed to construct the pool are purchased from resources owners in Wisconsin. Then will the increase in Real GDP for Minnesota be higher or lower than what was estimated in part (a)? Explain your answer.
Aside: This question was based on the move of the Cleveland Browns football team to Baltimore. Now think about the potential loss of losing the Twins or the actual loss of losing the North Stars back in the 1990s.
5. Illustration of two expenditures types changing simultaneously.
In the past decade, the Japanese government periodically tried to stimulate the economy out of a recession through its spending programs. For example, in the 1990s the Japanese government spent $1 trillion (or $1000b) on public works projects. One of those projects was a toll road built on the northern island of Hockkaido. Only 32 miles of the planned 160-mile highway has been completed at a cost of $1.9b or $60m per mile. Also, very few people use the road. This is largely because a highway that runs parallel to new toll road is free. (New York Times, 11/25/99).
a. If mpc = .8, how much do you expect the $1.9b expenditures on the highway to increase Japan’s real gdp (holding all other things constant)?
b. You can imagine that the wasteful nature of the government spending further reduced Japanese confidence about their economy. (Their confidence was already low because Japan was in a recession throughout the 1990s.) Suppose consumption fell by 1.2 billion. If mpc = .8, then what impact does the drop on consumption by 1.2 billion have on real gdp (holding all other things constant)?
c. What was the net impact of the increase in G and the decrease in C on real gdp? In other words, if both events described in question (a) and (b) occurred simultaneously, what will be the net impact on real gdp?
6. In 1939, with the U.S economy not fully recovered from the Great Depression, President Roosevelt proclaimed that Thanksgiving would fall a week earlier than usual so that the shopping period before Christmas would be lengthened. Explain the macroeconomic implication of his decision. Why did Roosevelt do this? (hint: think of the relevant macroeconomic concepts)
Optional Problems (Old Exam Questions):
1. Why did the deep Japanese recession of the 1990s adversely affect the rest of Asia? To answer this question, think in terms of exports to Japan. Also, note that the economies of East Asia are intertwined.
· A headline of a Star Tribune article “Financial Crisis Moves to Gulf Arab Nations”. Why would the U.S. and European financial meltdown adversely affect the Gulf economy as well?
2. Connection between the stock market and real GDP:
· Stock markets around the world fell after the European commission president warned that the crisis in the eurozone was threatening to engulf Italy and Spain. U.S. stocks sank more than 3% in response. Using the consumption and investment functions, explain how this announcement affected the US economy.
· The U.S. stock market has dropped amid news of: 1) the EU bailing out Ireland and expectations that Spain will also need to be bailed-out, 2) China’s efforts to slow down its economy, and 3) a three year investigation into insider-trading violations on Wall Street. How did this affect C, I, AE, AD, and RGDP?
3. “The Faribault Woolen Mills is weaving its way back from oblivion one thread and one American employee at a time. [In 1865], the Faribault Woolen Mills opened for business, shipping its products all over the world.” The factory continued operating until 2009 when it became bankrupted by poor management and a weak economy. It has now reopened and expects to have 200 employees working for them by next year. (Source: CNBC 11/6/11) Explain why one should expect more than 200 jobs to be generated by opening up this mill.
4. The U.S. Automotive Industry directly employs 355,000 jobs in the U.S., mostly in the upper Midwest. Explain why if the U.S. Automotive Industry collapses, one should expect more than 355,000 jobs to be lost in the United States. (WSJ articles on 2008 bailout of auto industry)
5. Japan has been experiencing deflation (i.e., falling price levels). Bank of Japan – the equivalent to the Federal Reserve – is expected to stick to its current monetary policy until is overcomes the mild deflation that continues to haunt Japan’s economy. (Source: WSJ 4/15/13) Given your macroeconomic knowledge, do you expect the Bank of Japan to lower or raise interest rates in order to raise the inflation rate? Explain.
6. Brazil, “Latin America’s biggest economy appears headed for one of its worst recessions ever. It stalled in 2014, shrank 3.8% last year and now faces a similar contraction this year. Unemployment rose to 9.5% on Thursday as wages fell 2.4%, both trends forecast to worsen. One in five young Brazilians is out of work, and Goldman Sachs says Brazil may be facing a depression.” Source: WSJ 3/25/16) Given your macroeconomic knowledge, do you expect the Central Bank of Brazil to lower or raise interest rates to lower unemployment? Explain.
7. The Venezuelan government has devalued its currency, bolivar. This makes foreign products look cheaper to Venezuelans and makes Venezuelan products look more expensive to foreigners. Will this raise or reduce inflation in Venezuela? Explain.
8. Japan’s Prime Minister Shinzo Abe has directly pressured Japanese firms to raise wages. Openly pushing companies to raise wages is just one of the unorthodox economic policies attempted under the Abe government to jump-start an economy that seems stuck in a long-term bad equilibrium. (Source: WSJ 3/17/16) Explain how rising wages would affect Japanese household consumption and Japanese business investment.
9. Billionaire Warren Buffet said rich people should pay more in taxes and Bush-era tax cuts for top earners should be allowed to expire at the end of December: “If anything, taxes for lower and middle class, and maybe even the upper middle class, should even probably be cut further.” (Source: ABC’s “This Week with Christine Amanpour” 11/10) Provide a macroeconomic explanation to support Warren Buffett’s assertion to reduce taxes on poor and middle class over the rich.
10. During the 1970s, President Ford proposed that taxes be decreased but, to avoid increasing the government budget deficit, the government spending should be decreased by the same amount.
· How much did real GDP change by if taxes and government spending were both decreased by $3 trillion and mpc is .75?
· Did President Ford achieve his goal to raise economic growth?