AMERICAN UNIVERSITY
Department of Economics
Comprehensive Examination
Advanced Heterodox Theory
January 2014
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Instructions: This exam has two sections, Macro and Micro. You must answer both sections;
follow the directions in each section carefully. Each section receives equal weight in the grading;
therefore, you should spend an equal amount of time (about 2 hours and 30 minutes) on each
section (Macro and Micro). Please make sure that all math and graphs are intuitively explained,
all diagrams are clearly labeled, and all answers are responsive to the specific questions asked
(no credit for extraneous material). The time limits suggest the expected length and depth of your
answers. Only the nonprogrammable calculators provided by the proctor are permitted; no other
electronic devices are allowed. All answers are expected to demonstrate mastery of the material
at the PhD level.
MACRO SECTION (2 hours and 30 minutes total)
Directions: There are two parts, A and B. You must answer both parts; there is some
choice in Part B. Allocate 1 hour and 15 minutes for each part.
Questions for the Macro Section begin on the next page 
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Part A – Mandatory Question (no choice) [1 hour and 15 minutes]
1. There are many versions of a “new consensus” or “New Keynesian synthesis” macro
model that have the following basic structure (where time subscripts and lags of variables
are deliberately omitted, so that you can make suggestions about adding them later):
Aggregate demand (1):
y = a0 – a1(i – pe) + η
Aggregate supply or Phillips curve (2):
p = pe + b0 + b1 y + ε
Monetary policy or Taylor rule (3): i = i0 + pe + c1y + c2(p – p*) + ν
where y is an output variable (depending on the model, it could be the output gap or capacity utilization rate, and it could possibly be replaced by the employment rate in some
equations), i is the nominal interest rate, p is the inflation rate (log change in the price
level), pe is the expected inflation rate, p* is the target inflation rate of the central bank,
b0 is a parameter reflecting labor-management bargaining, and η, ε, and ν are shocks to
aggregate demand, aggregate supply, and monetary policy, respectively. You may
assume that ai, bi, ci > 0 for all parameters shown above.
a. What changes or modifications of this basic model (including additional variables
that should be added, ways of specifying some of the variables or coefficients,
particular lag structures, etc.) would be recommended by various alternative
macro theories? Be sure to consider the new consensus theory itself as well as
neo-Kaleckian models and the work of Akerlof et al. on near-vs.-full rationality,
Ball and Moffitt on “wage aspirations,” Hein and Stockhammer on NAIRU models/stories, and Svensson on inflation targeting. Discuss the rationale for each of
the recommended changes or additions to the basic model and their main implications.
NOTE: You do not need to give complete details for each of these
approaches, nor do you need to create one big synthetic model; rather, you
should indicate what specific modifications to the basic equations are
implied by each approach, and discuss their motivations and implications.
b. Are there any additional modifications to the basic macro model given above that
you would recommend based on the experience of the financial crisis and “Great
Recession” of 2008-9 and the subsequent slow recovery of the U.S. economy?
What important features of the recent crisis and policy responses are ignored or
assumed away in this model, which are important for explaining both the origins
of the crisis and the prolonged, slow recovery from the recession? Be as specific
and detailed as possible about any further changes you think the model needs.
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Part B – Choose one (1) of the following two questions [1 hour and 15 minutes]
1. Consider an open economy neo-Kaleckian model characterized by the following equations (there is no government sector and no depreciation of capital for simplicity):
Mark-up pricing: P = (1 + z)Wa0 (z > 0 is the mark-up rate, W is the nominal wage, and
a0 is the labor coefficient [labor hours/output])
Real exchange rate: q = EP*/P (E is the nominal exchange rate in domestic/foreign
currency; P* is the foreign price level)
Wage share:  = Wa0/P
Profit rate: r = (1 – )u (where u = Y/K is a proxy for the capacity utilization rate)
Saving function:  = S/K = srr (the saving rate out of profits is 0 < sr < 1; there are no
savings out of wages)
Investment function: g = I/K = g0 + g1u + g2π
(g0, g1, g2 > 0)
(b1, b2 > 0)
Trade balance: b = B/K = b0 + b1q – b2u
Wage adjustment: Wˆ   ( w  ) where w is the workers’ target wage share
(note  = 0)
Price adjustment: Pˆ   (     q ) where  reflects the degree of competition ( is
inversely related to concentration or monopoly power), and ,  > 0
Exchange rate adjustment (“crawling peg” managed exchange rate): Eˆ   ( q  q ) ,  > 0
a. Let  = EP*/ Wa0 be the real exchange rate in terms of unit labor costs. Demonstrate that q = .
b. Solve mathematically for the short-run equilibrium level of u; find an explicit
(reduced form) solution for the equilibrium utilization rate u as a function of , ,
and other exogenous (in the short run) variables and parameters. Be sure to use q
=  to substitute for q where necessary.
c. Is aggregate demand (measured by u) wage-led or profit-led, or can it be either, in
the short run? Find the appropriate derivative (again, get a reduced, explicit solution) and analyze its sign. If the sign is ambiguous, find and interpret the condition for wage-led vs. profit-led demand in terms of the parameters of this model.
Find and use the stability condition as needed.
d. Show the derivation of the two demarcation curves (isoclines) for income distribution and the real exchange rate in the medium run, ˆ = 0 (DC curve) and q̂ =
0 (FE curve). Draw on a diagram. Find the slopes and relate to the stability of the
medium-run equilibrium for  and q.
e. Analyze the effects of each of the following on medium-run equilibrium q, , and
u, assuming (if this was not found in part c.) that demand is wage-led in the short
run; your answer should be mainly graphical and intuitive (full math is not required in this part). Analyze and discuss intuitively whether the medium-run outcomes including open economy effects are wage-led, profit-led, or can be either.
i. A currency appreciation policy (a fall in the monetary authority’s target
for the real exchange rate, q ).
ii. An increase in the bargaining power of labor, as indicated by a rise in the
workers’ target wage share, w.
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2. Analyze the effects of the parameter changes indicated below in particular “closures” of a
model of growth and distribution, assuming an inverse wage-profit relation given by
1 a
w  1 r
a0 a0
where w is the real wage, r is the rate of profit, a0 is the labor coefficient (hours per unit
of output), and a1 is the capital coefficient (capital per unit of output). Combining math,
graphs, and intuition, determine and explain the impact of the following changes on the
endogenous variables w, r, profit share , and/or accumulation rate g (as appropriate to
each model) in each of the following cases (do NOT analyze consumption per worker c):
a. A fall in the wage share (rise in  ) in a Classical-Marxian model with an exogenously given wage share ( 1   ), where capital accumulation is determined by the
function g = αr (where 0 < α < 1; you may assume no minimum profit rate, rmin =
0, for simplicity).
b. A rise in the growth rate of labor supply in a Classical-Marxian model with a constant unemployment rate (full employment/natural rate of growth, g = n) where
the growth of labor supply is exogenous (n = n0) and you may use the same accumulation function as in part a.
c. An increase in “animal spirits” in a Neo-Keynesian model, in which the classical
accumulation function is replaced by a saving function   S/K = srr and an independent investment function g  I/K = f0 + f1r, f0, f1 > 0 (you may model the increase in animal spirits as a rise in f0).
d. A rise in the mark-up rate τ in a Kalecki-Steindl model, allowing for variable
capacity utilization u = Y/Y* (where Y is actual output and Y* is potential output),
with 0 < u < 1, and the investment function is g = g0 + g1r + g2u (g0, g1, g2 > 0),
while the saving function is the same as in part c. For this model, you may assume
that prices are set by P = (1+)Wa0, where W is the nominal wage rate, and the
inverse w-r relation (with w = W/P) is modified to incorporate variable utilization.
e. Finally, discuss (compare and contrast) what your results show about the relationship between distribution (the wage share) and growth (the rate of capital accumulation) in these four models. Are more equitable distribution and more rapid
growth positively or inversely related in each one? What different assumptions
account for the different implications in this respect?
The Micro Section starts on the next page 
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MICRO SECTION (2 hours and 30 minutes total)
This section has two parts A and B; you must answer both parts and there is some choice in
each part. Pay careful attention to the time limits!
Part A - Essay Questions – Answer one (1) of the following. (1 hour and 15 minutes)
1. Theories of economic development have increasingly focused on the important role of
institutions. Drawing on Bowles’, Knight’s, and Greif’s analysis of institutional evolution,
carefully explain an “Evolutionary Political Economy” theory of underdevelopment and offer
relevant examples to support the theory.
2. While Neo-classical economics models individuals as fully informed agents pursuing
exogenously determined, individualist preferences, Evolutionary Political Economy models
humans as partially-informed, backward-looking updaters, who maximize endogenously
determined preferences which are sometimes social. Based on empirical papers you have
read, describe some of the evidence supporting the assumptions of EPE.
Part B - Long Answers. Answer one (1) of the following. (1 hour and 15 minutes)
1. Let a standard prisoner’s dilemma illustrate the exchange problems created where incomplete
contracts create the possibility of cheating (Defect). Note: a > b > c > d and a + d < 2b.
Cooperate
Defect
Cooperate
b, b
a, d
Defect
d, a
c, c
Some argue that, in this context, institutions (like the use of repetition and retaliation) can
permit decentralized interactions to generate more efficient results. Define the probability, ρ,
that the game (exchange interaction) will be terminated after this round, and the share of the
population = τ that will be playing tit-for-tat. All others play defect.
1.1 Write down payoff functions for the two types of agents.
1.2 Find the equilibrium share of tit-for-tatters mixed population, τ*. How many equilibria
are there? Are any pure population equilibria?
1.3 Which equilibria are stable? Show both graphically and mathematically. Can you say
anything about which equilibrium is most likely? Explain the process by which players
might arrive at that equilibrium from another situation.
1.4 Suppose ρ increases. Show how this affects τ*.
1.5 Discuss some empirical evidence about the use of such institutions in facilitating
exchange.
1.6 Could τ be a quasi-parameter, in the Greif-ian sense? If an increasing share of tit-fortatters in the population causes the probability of termination to fall (say exchange
becomes more stable in a population where more people play tit-for-tat), what would
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Greif say about the long run stability of τ*. Explain.
2. Chris (C) and Pat (P) are partners in a household with one child. Chris earns an income of
$400 per week and Pat earns an income of $200 per week.
They are each trying to allocate 50 hours of free time weekly between play time with their
child (K), and personal leisure (L) (time spent working in the market is exogenous). Thus, the
time constraint is given by 50= Ki + Li .
Play time is a public good, i.e., Chris and Pat derive utility from the amount of time each
parent spends playing with their child.
In the event of divorce, social norms require that Chris and Pat individually spend 20 hours
of play time with their child. Each no longer derives utility from their partner's play time with
their child (i.e. play time is no longer a public good).
Their utility functions take the following form:
1
m
1
U C  ln 400  ln K C  ln K P  ln LC ,
4
4
2
1
m
1
U P  ln 200  ln K P  ln K C  ln LP ,
2
4
4
where m is an indicator variable which takes the value 1 if the couple stays married, and 0 if
the couple decides to divorce.
2.1 What are the divorce threat points (m = 0, those that would be used for the cooperative
Nash game)?
2.2 What is the equilibrium allocation under a non-cooperative marriage? Compare to the
divorce threat points. Why are these different?
2.3 How will the threat points change if Pat is altruistic, giving a weight of 0.3 to Chris’
utility? How will this change the Nash bargaining equilibrium (in general, do not attempt
to solve for it)? Explain this outcome.
2.4 Use a cooperative or non-cooperative model of marriage to explain rising divorce rates in
the west after women entered the labor force in the 1970s. Provide some empirical
evidence for your analysis.
2.5 In what sense does power affect the outcome of cooperative bargaining? Of noncooperative bargaining? (Be clear how you define power and what possible sources of
this power are.)
2.6 In some places, divorce is not an acceptable way to resolve conflict. What are some
possible sources of power in such contexts? Explain how these would enter into a
bargaining model of your choice.
(End of exam)