EC108 Macroeconomics 1
Review Class 2∗
Jorge F. Chavez
May 8, 2015
1
True or false
Indicate whether the following statements are true, false or uncertain. Explain your answer.
(a) Tax cuts decrease national savings.
(b) Faster money growth causes inflation to increase.
(c) In the Solow model, economies with faster population growth have lower per capita incomes.
(d) According to Ricardian Equivalence, government spending does not affect saving.
(e) Reducing inflation causes the unemployment rate to rise.
(f) The growth rate of nominal GDP always exceeds the growth rate of real GDP.
2
Unemployment
Indicate whether each of the following people is frictionally unemployed or structurally unemployed
or cyclically unemployed or not officially unemployed. Explain your answer.
(a) A poorly educated former telephone operator, replaced by a machine, looking for work.
(b) A woman with good job skills who cannot find a job due to a sluggish economy.
(c) A 17 year old with good job skills looking for a job.
(d) A welfare recipient with good job skills who is not looking for work.
(e) A man with obsolete job skills who has given up trying to find work.
∗
Disclaimer: None of these questions are mine, they come from several sources that I collected through the years. In
some cases I adapted those from their original versions to fit the requirements of our module.
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EC108
3
Review May 2015
Money and inflation
The quantity theory of money (Fisher 1911) asserts that money demand is proportional to nominal
income, i.e. Md = kP Y , with k constant.
1. What is the velocity of circulation of money according to this specification?
2. Modern theory of money demand considers the nominal interest rate as a further determinant
of money demand. Specifically Md = P L(Y, i), with L increasing in Y and decreasing in i. Give
intuition for why L decreases with i.
3. Consider the further assumption that the L(Y, i) function is separable, i.e. L(Y, i) = Y ℓ(i),
with ℓ decreasing in i. Is money demand still proportional to nominal income as in the original
quantity theory?
4. Obtain an expression for velocity in this new specification. How would you expect velocity to
change with an increase in i? Provide economic intuition for this effect. How does this result
differ from the original quantity theory?
4
Solow and inmigration
Three economists are debating whether an increase in the number of immigrants will increase, decrease
or have no effect on the growth rate of the domestic economy. Use the Solow model to justify each
of their arguments. Hint: Take into account that immigrants could arrive with some endowment of
capital k ≥ 0.
5
Solow II
An economy described by the Solow growth model with technological progress has the following
production function:
y=
√
(k)
where y denotes output per effective worker, y = Y /(AL), and k denotes capital per effective worker,
k = K/(AL)
(a) Solve for the steady state value of y as a function of parameters s, n, g and δ?
(b) A developed country has a saving rate of 28% and a population growth rate of 1% per year. A
less-developed country has a saving rate of 10% and a population growth rate of 4% per year. In
both countries, g = 0.02 and δ = 0.04. Find the steady-state value of y for each country.
(c) What policies might the less-developed country pursue to raise its level of income?
Jorge F. Chávez
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