Exercise 1
ECO102
June 14, 2021
Question 1 (10 marks). In late 2000 economists were debating whether the
U.S. economy was in recession. GDP seems to be rising, yet the unemployment rate was stuck at close to 10 percent. In thinking about the economic
distress experienced during the recession, which is the most important: high
unemployment or falling GDP? Defend your answer.
Question 2 (10 marks). On average, nations in Europe pay higher unemployment bene…ts for longer periods of time than does United States. How do you
suppose this would impact the unemployment rates in these nations? Explain
which type of unemployment you think is most directly a¤ected by the size and
duration of employment bene…ts.
Question 3 (10 marks). Suppose all wages. salaries, welfare beneÖts, and
other sources of income were indexed to ináation. Would ináation still be considered a problem? Why or why not?
Question 4 (10 marks). An article in the Gotham Times states that the
stock of capital and the workforce in Gotham are both increasing at an annual
rate of 7 percent. The same article states that real output is growing by 11
percent. Explain if this is possible in the short run and in the long run.
Question 5 (10 marks). Assume in country Y, the average marginal propensity to save is 0.2. When the aggregate income is zero, consumers spend 50 to
consume. Derive the saving function and consumption function for this country.
What happens to consumption when when the propensity to save decreases to
0.1? Explain your answer and show this on the graph.
Question 6 (10 marks). Explain the di¤erence between actual investment
and planned investment. When are actual investment and planned investment
equal? When is actual investment greater than planned investment? When is
actual investment less than planned investment?
Question 7 (10 marks). The Economics in Practice describes some of the
di¢ culties that households have with regard to decisions involving tradeo§s
between the present and the future. Explain brieáy how the problem of global
warming and the problem of adequate household saving are similar. Describe
1
ways in which the concept of opportunity cost can be used to frame these two
problems. What barriers might prevent households or societies from achieving
satisfactory outcomes?
Question 8 (10 marks). We argued that saving and spending behavior depends in part on wealth (accumulated savings and inheritance), but out simple
model does not incorporate this e¤ect. Consider the following model of a simple
economy: C = 50 + 0:8Y + 0:1W
I
W
Y
S
= 200
= 500
= C +I
= Y C
If we assume that wealth (W ) and investment (I) remain constant (we are ignoring the fact that saving adds to the stock of wealth), what are the equilibrium
levels of GDP (Y ), consumption (C), saving (S)? Now suppose that wealth increases by 100 percent to 1000. Recalculate the equilibrium level of Y , C and
S. What impact does wealth accumulation has on GDP? Many were concerned
with the large increase in stock values in the late 1990s. Does this present a
problem in the economy? Explain.
Question 9 (10 marks). A $1 increase in government spending will raise
equilibrium income more than a $1 tax cut will, yet both have the same impact
on the budget deÖcit. So if we care about the budget de…cit, the best way
to stimulate the economy is through increases in spending, not cuts in taxes.
Comment.
Question 10 (10 marks). You are appointed secretary of the treasury of
recently independent country called Rugaria. The currency of Rugaria is the
lav. The new nation began …scal operations this year, and the budget situation
is that the government will spend 10 million lavs and taxes will be 9 million lavs.
The 1-million-lav di¤erence will be borrowed from the public by selling 10-year
government bonds paying 5 percent interests. The interest on the outstanding
bonds must be added to spending each year, and we assume that additional
taxes are raised to cover that interest. Assuming that the budget stays the same
except for the interest on the debt for 10 years, what will be the accumulated
debt? What will the size of the budget be after 10 years.
2