QUIZ 2: Macro – Winter 2009
SOLUTIONS
Question 1
True or False? (No explanation, 1 point each – 6 total)
a. According to the AD-AS model I have previewed in class, the fact that the
expansion of the 90s was mainly characterized by declining inflation is consistent
with a positive demand shock.
FALSE. According to the AD-AS model we have sketched in class, after a
positive demand shock, output would go up and prices would go up, while
after a positive supply shock output would go up but prices would go down.
According to this model, the expansion of the 90s seems due to a positive
supply shock and indeed many economists think that it was due to a
sustained increase in TFP!
b. Students and retirees do not work, and hence are measured in the stock of the
unemployed workers.
FALSE. Unemployed workers are only workers who do not have a job but
are part of the labor force, in the sense that they actively look for a job.
c. If people expect the Fed to increase the interest rate in the future, the yield curve
tends to be upward-sloping.
TRUE. If people expect the Fed to increase the interest rate in the future,
then the interest rate on longer maturity bonds tend to be higher than the
one on shorter maturity bonds, because otherwise everybody would buy
short-term bonds and then reinvest the proceeds in the higher future shortterm bonds!
d. If you compare labor productivity Y/N in France and in the US, it is better to
measure N as hours worked rather than as number of workers, given that the
typical work-week hours are very different between the two countries.
TRUE. If N is measured as number of workers, then French labor productivity
would be underestimated in comparison to the US one, given that each worker
works much less hours. For example if Y/N is the same in France and US, this
means that workers in France are more productive!
e. If there are diminishing returns to capital, as the capital stock increases an
additional unit of capital increases output by a smaller amount.
TRUE. This is the definition of diminishing returns to capital.
f. TFP growth rate cannot be measured even if we assume that the production
function is Cobb-Douglas.
FALSE. As we have seen in class, if we assume that the production function
is Cobb-Douglas, then we can measure TFP growth rate as a residual!
Question 2
Imagine in Country X, the data on GDP (Y), capital (K) and labor (N) in 2007 and 2008 are the
following:
Year
Y
K
N
2007
2008
2000
2100
250
300
1250
1200
Assume that the production function of Country X can be well approximated by the
Cobb-Douglas form:
Y = AK0.3N0.7 .
Hence, the growth accounting equation is the same we have seen in class:
ΔY/Y = ΔA/A + .3 ΔK/K + .7 ΔN/N
a.
What is the growth rate of TFP (A) between 2007 and 2008? --- 4 points
First, you can calculate the growth rate of K, N, and Y:
ΔY/Y = (Y(2008)-Y(2007))/Y(2007) = 0.05
ΔK/K = (K(2008)-K(2007))/K(2007) = 0.2
ΔN/N = (N(2008)-N(2007))/N(2007) = -0.04
Using the growth accounting equation above, we then can calculate the growth rate
of A:
ΔA/A = ΔY/Y - .3 ΔK/K - .7 ΔN/N = 0.018
1.8%
b.
What is the growth rate of labor productivity (Y/N) between year 2000 and 2008?
--- 4 points.
Here you could answer both using the approximated formula or using the exact
formula.
With the approximated formula, the growth rate of labor productivity is equal to:
ΔY/Y - ΔN/N = 0.09
With the exact formula
Y/N(2007) = 1.6
Y/N(2008) = 1.75
Then Δ(Y/N)/(Y/N) = (1.75 – 1.6)/1.6 = 0.09
9%
Question 3
Recent data show that inflation in December 2008 reached 0.7%, one of the lowest level since
1954! This big drop was unexpected and was much below any measure of expected inflation.
Suppose expected inflation at the end of 2007 was 2.7%. Suppose that at the end of 2007 Mary
borrowed $100,000 at the yearly nominal interest rate of 6.7%. What was her expected real
interest rate when she decided how much to borrow? What was the realized real interest rate she
had to pay at the end of 2008? Did she gain or lose in comparison to her expectations?
--- 4 points
When Mary decided to borrow, her expected real interest rate was
re = i - πe = 6.7% - 2.7% = 4%.
When instead at the end of 2008 the realized inflation turned out to be 0.7%, then
the effective real interest rate she had to pay was
ra = i - πa = 6.7% - 0.7% = 6%.
Hence, she had to pay higher real interest rate than what she expected, losing money in
comparison to her expectations.
Question 4:
In the Economist article entitled “To these, the spoils”, the journalist reports “a new study
by Stephen King, chief economist at the HSBC bank, concludes that workers and
consumers have received the lion's share of the productivity gains of the revolution in
information technology (IT)”. The journalist reports that in 1997-2000 despite a surge in
productivity, non-financial firms profits decreased. Why is that? Report one of the reason
explained in the article. (Your answer should not be more than a 10 words!)--- 4 points
You get full credit if you report any of the following:
1) There was a fall in the IT goods that consumers bought
2) The IT spurred competition across firms, squeezing prices and profits
3) Globalization has reduced the pricing power of the firms even further