Comprehensive Examination January 2004
ECON 06A - Political Economy II Page 1 of 5
Directions: This examination has two sections, Macroeconomics and Microeconomics. You must answer
the required number of questions in both sections. Each section receives equal weight in the grading; you
should plan to spend an equal amount of time on both sections, regardless of the number of questions in
each. Make sure your answers are responsive to the specific questions asked, all math is intuitively
explained, and all diagrams are clearly labeled.
MACROECONOMICS SECTION
Choose two (2) questions from the following (time allocation: about 60 minutes each):
1. Both David Ricardo and Karl Marx had theories of a falling tendency of the rate of profit (FTRP).
Compare and contrast the two theories, explaining each one in detail, and paying special attention to the
following questions: What is the role of technological change in each one’s theory, either as cause or cure
for the FTRP? What happens to the real wage during the growth process as the profit rate falls in each
theory, and why? (Be sure to discuss Casarosa’s interpretation of Ricardo with regard to wages.) What are
the offsetting factors or counteracting tendencies that can prevent an FTRP in each one’s view? Be as
specific as possible, and explain in depth how the two views of an FTRP differ.
2. Discuss the implications of any three (3) of the following theories for what kinds of government policies
would best promote long-run growth and/or higher living standards:
a. Old neoclassical (Solow) growth model
b. Investment-constrained neo-Keynesian/Kaleckian growth model (Foley & Michl version)
c. Balance-of-payments constrained growth model
d. Export-led growth with cumulative causation
For each theory you discuss, give a rigorous explanation of the policy implications of that model, and be
sure to explain whether it implies that the pro-growth policies favored by that theory can increase the longrun equilibrium growth rate or, if not, what other beneficial effects those policies are supposed to have. Be
as specific as possible. Also compare and contrast the policy implications of the three theories you choose.
Are there policies that make sense in terms of one model that would be ineffective or even
counterproductive under another model? Discuss.
3. Consider the following “conflicting claims” model of inflation, in which workers’ and firms’ reaction
function are specified in terms of targets for the wage share, defined as v = WN/PY (where W is the
nominal wage rate, N is employment of labor, P is the price level, and Y is real output). Workers and firms
set nominal wages and prices (respectively) according to the following adjustment functions:
where a “^ ” over a variable indicates an instantaneous rate of change, i.e., for any variable x, . Workers set
their target wage share directly at vw, while firms set a target profit mark-up rate ?f. In addition, there is
positive labor productivity growth at the rate , where labor productivity is defined as q = Y/N. You may
take ? as exogenously given.
a. Show how the capitalists’ implicit target wage share vf is derived from their target profit mark-up rate,
assuming that prices are determined by the mark-up equation P = (1+?)W/q.
b. Explain the intuition for the wage and price adjustment equations given above.
c. Solve for the equilibrium rate of price inflation and the equilibrium wage share v*, assuming that
equilibrium is defined by a constant steady-state wage share ( ).
d. Is the equilibrium rate of wage inflation the same as the equilibrium rate of price inflation you found in
part c.? Why or why not? What happens to the real wage b = W/P in the steady-state equilibrium described
in part c.? Explain.
e. Now calculate the effects of an increase in the rate of productivity growth ? on the equilibrium inflation
rates and wage share, and explain your results intuitively.
f. How are your results in part e. relevant to the behavior of inflation in the U.S. economy since the late
1990s? Discuss briefly.
4. Consider an economy described by a neo-Kaleckian macro model in which the investment function is
where gi = I/K is desired investment in proportion to the capital stock, with f0, f1, f2 > 0; r = ?u is the profit
rate; ? is the profit share (taken as exogenously given); and u = Y/K is the output-capital ratio, taken as a
proxy for capacity utilization. Answer the following questions:
a. Explain what it means that this investment function assumes a “strong accelerator condition.” Be as
precise as possible. Do not refer to any other equations or parts of a macro model other than the investment
function itself.
b. Next, consider combining this investment function with the saving function
where sr and sw are the saving rates out of profit and wage income respectively, in the special case where
wage and profit income are saved at the same rate, i.e., sw = sr = s (where s is a traditional Keynesian
“marginal propensity to save” and 0 < s < 1). What happens to the saving function in this case? Solve for
the equilibrium utilization rate u, find the stability condition, and determine whether the economy is
“stagnationist” or “exhilarationist” (or could be either one) under this assumption. How can you reconcile
your result with the existence of a “strong accelerator condition” in the investment function? Discuss
intuitively.
c. Demonstrate that this model exhibits a “paradox of thrift” (in terms of the equal saving rate s) and
explain your result intuitively. How is your result affected by the “strong accelerator condition” in the
investment function—does this make the paradox of thrift effect weaker or stronger? Why?
MICROECONOMICS SECTION
This section has two parts, A and B. You must answer at least one question from each part plus one
additional question from either part, for a total of three (3) questions (time allocation: about 40 minutes
each).
Part A
1. Contingent Renewal and Firm Behavior. In a firm,
? = pQ(e,N) ? W, where W is the sum of w for all workers, or W = wN.
Workers’ discounted utility of work is:
V = aw?b/(1?e)
1?e
Once the employer chooses w*, employees choose e*.
a. Find e* in terms of w*, i.e. maximize V with respect to e.
b. Set p = 1. Maximize profit subject to the workers’ effort function, choosing both N and w. Explain these
FOCs. Solve for the w* which allows both conditions to hold, given the workers’ best response function e*.
c. How does this outcome differ from the outcome of wage determination in the simple neo-classical
model? What assumptions of political economists produce the differences in outcome? What are the
economic implications of the differences in outcomes?
2. Explain the Rotten Kid Theorem of Gary Becker.
a. What is this model meant to show?
b. Write down a generic cooperative Nash bargaining model and explain how this illustrates an alternative
view of how households allocate resources.
c. Based on this model, as well as the other theoretical and empirical literature we have seen, is an increase
in a woman’s earnings certain to result in an increase that woman’s bargaining outcome? Explain.
3. Chose Your Model:
a. List three premises of the Walrasian model that are rejected by the evolutionary Political Economy
approach.
b. Give two examples of how the change in assumptions results in predictions distinct from those used in
neo-classical models.
c. Discuss empirical evidence which supports the alternative assumptions.
4. Suppose that the population consists of two groups (call them x and y) with distinct characteristics and
norms (the characteristics are referred to as “strategies”). Payoff functions to the strategies of x and y are:
bx(p) = p?(x,x) + (1?p) ?(x,y) and
by(p) = p?(y,x) + (1?p) ?(y,y),
where p is the share of the population who are “x’s” and ?(?) defines the payoff to the strategic interaction
specified. Suppose that, initially, the two populations (groups) are separate.
a. Under what conditions can a small number of y’s invade the population of x’s?
b. Write down the replicator equation to define the rate of change of the two groups in the population after
the invasion.
c. What will be the equilibrium (p, p*) in the invaded population?
d. Give one real world example of such an interaction of groups with distinct behavioral norms.
Part B
1. Hahnel & Albert present a model of the conflict theory of a competitive firm in which one kind of labor
is employee empowering and the other kind is employer empowering in chapter 8 of Quiet Revolution in
Welfare Economics. Explain what the effect of lower employee turnover rates in their model would be on
the efficiency of the economy. Michael Reich presents a different model of the conflict theory of the firm
with an employer, white workers, and black workers in the appendix to chapter 5 of his Racial Inequality.
Explain exactly what the employer, black workers, and white workers win or lose in his model when
employers engage in wage discrimination.
2. It was commonly assumed that treating preferences as endogenous would require welfare analysts to
make judgments that some human characteristics and the preferences they give rise to are better than other
human characteristics and the preferences they generate based, ultimately, only on the personal opinions of
the analysts. Briefly explain the basis for this concern. Hahnel & Albert present a model of endogenous
preferences in chapter 6 of Quiet Revolution in Welfare Economics that purports to avoid this dilemma.
Explain what they argue is the key feature in their model that permits an “end run” around this seemingly
intractable problem, and evaluate their proposed “solution.”
3. Suppose the bargaining power of employers and employees in a two-sector economy with the below
coefficients is such that capitalists are able to command a 20% rate of profit.
a11 = 0.2 a12 = 0.3
a21 = 0.3 a22 = 0.2
L1 = 0.4 L2 = 0.2
a. With p2 = 1, what will p1 and the wage rate be? Show your work.
b. Suppose capitalists in sector 1 discover the new, capital-using, labor-saving technique below. Will they
replace the old technique with the new one? Show your work.
a11' = 0.2
a21' = 0.4
L1' = 0.34
c. Assuming the capitalists in sector 1 do what you just said they would, will they, or will they not, have
served the social interest? Show your work and explain your reasoning.
d. In general, under what conditions will Adam Smith’s second “invisible hand” lead capitalists to serve the
social interest while serving their own private interests when choosing between alternative technologies,
and under what conditions will it not? Explain the intuition behind your conclusion.