MGEB05 – LEC 01

Macroeconomic Theory and Policy

Assignment 1

Due: On (or before) Friday, February 7, 2024, 5:00pm, Quercus (under MGEB05 Assignment 1)

(Assignments submitted after 5:00pm on February 7 will NOT be accepted.)

Instructions:

.   You can submit an individual or group assignment.   If you submit a group assignment, there must be no more than FIVE students in your group, and you just submit ONE copy for the group.

→ If you are planning to submit a group assignment, make sure you form your group on Quercus (under HW-1Group#) before submission.

.   Label your graph(s); otherwise, marks will be subtracted.

.   No credit will be given if you do not show your work (i.e., don’t simply say the answer is 3 write down enough of the steps you used to arrive at this answer).

.   Your answer should be structured in a way such that those that know little about economics will have no difficulty understanding your argument/answer.

.DONOTUSEanynotationsorabbreviationsthatarenot beingusedinlectures.Ifyouuseyour ownnotationsand/orabbreviations,youwillreceivea gradeof zeroforthatquestion.

.   Total marks: 100 points.

Question 1 (20 points) – Topic 1 (save your answer as HW1-Q1.pdf)

The following table provides the economic data for an economy.

Here is some additional information about this economy that holds true for all three years:

.   Unless  otherwise  stated, the goods are produced within the economy and are consumed by local sectors.

.   Consumers consume half of Good 1, while foreign governments purchase a quarter.  The remaining quantity of Good 1 is consumed by the local government.

.   Good 2 consists of office supplies that are consumed exclusively by firms and are entirely produced abroad.

.   Good 3 is equally distributed among households, firms, government, and foreign businesses.

.   Good 4 is a pure consumption good; however, four-fifths of the products is purchased outside the country.

.   Good  5  is  a  pure  consumption  good,  equally  split  between  domestic  households  and  foreign households.

.   Good 6 is purchased by businesses and the government.  The distribution of Good 6 between firms and the government were 60% and 40%, respectively.

.   The government chooses Year  1 as the base year.   In the base year, both the GDP deflator and the CPI were normalized to 100.

Based on the information iven com lete the followin table

Note:

.   The above table is reproduced on page 4 of this assignment (so that you can print it & fill it out). You must submit that page as your answer to Question 1 with your assignment for grading.

.   Also,  on  separate page(s), show your work! You  are required to do both; otherwise, you will receive a grade of zero for this question.  Keep your answer to 2 decimal places if needed.

Question 2 (30 points) – Topic 2 (save your answer as HW1-Q2.pdf)

A closed economy can be described by the long-run classical model:

Y = 2K⅓L⅔

C = 7800 + 0.75(Y – T) – 350r

I(r) = 6000 – 250r

MPK = ⅔K–⅔ L⅔            MPL = (3/4)K1/3 L-1/3

Note:  r is measured in decimal form (i.e., if r = 0.1, then r is equal to 10%).  Keep your answer to 4 decimal places or fractions if needed.

The government sets the income tax rate to 9% of (long-run) output, and it runs a budget deficit of 1000.  Initially, the economy is endowed with 8000 units of capital and 64000 workers.

a)  Find the equilibrium levels of output, real interest rate, and investment.  Also, find the equilibrium real wage for labour and real rental price of capital.  (7 points)

The economy is initially in its equilibrium as shown in part (a).  Following the recent release of the job market data, a wave of pessimism sweeps the country, leading households to adjust their spending on final products.  As a result, autonomous consumption changes by 2%.

Note:  you need to decide whether autonomous consumption increases or decreases.

b)  Find the new equilibrium levels of output, real interest rate, investment, real wage for labour, and real rental price of capital.  (7 points)

c)   Show your answers for parts (a) & (b) in three diagrams that depict the loanable funds market, the labour market, and the rental market for capital in long-run equilibrium.  Be sure to identify which points on your diagrams are the long-run equilibria for part (a) & (b) respectively.   No written explanation is required.  (9 points)

Note: All  submitted diagrams must be drawn by hand  (i.e., you  are NOT allowed to use any drawing/diagramming tools or software).   However,  you  may hand  draw the diagrams on your tablet(s).  Failure to submit hand-drawn diagrams will result in a grade of ZERO for this part of the question.

d)  (Continue from part b) Suppose the government wants to keep the (equilibrium) level of investment to 5975 via a change in government spending.  Find the level of government spending that could achieve this goal.   What  happens to the budget balance (i.e., increase or decrease, and by how much)?  (7 points)

Question 3 (25 points) – Topics 2 & 3 (save your answer as HW1-Q3.pdf)

Canada is a closed economy and is initially in its long-run equilibrium.   Due to climate change, the frequency   and   severity   of  natural   disasters   in   the   country   have   been   increasing   over  time. Unfortunately, these natural hazards destroy some of the infrastructure.

In the context of the long-run classical model, examine the effects of the above event on the following variables in the long run:

.   output

.   real interest rate

.   investment

.   real rental price of capital

.   real wage

.   aggregate price level

Explain your answer with the aids of ONE diagram for the market of loanable funds, ONE diagram for the rental market for capital, and ONE diagram for the market for labour.

Note:  All  submitted  diagrams  must  be  drawn  by  hand  (i.e.,  you  are NOT allowed  to  use  any drawing/diagramming tools or software).  However, you may hand draw the diagrams on your tablet(s). Failure to submit hand-drawn diagrams will result in a 30%-mark deduction for the question.

Question 4 (25 points) – Topics 1, 2, & 3 (save your answer as HW1-Q4.pdf) Each part of the question is NOT related to other parts.

a)   The November 2024 Labour Force  Survey released by Statistics Canada on December 6, 2024,  indicated that the level of employment increased by 51000, driven by the increase in full-time  positions.  However, Canada’s unemployment rate rose by 0.3 percentage points in November 2024, compared to a month ago.  Explain these seemingly contradictory observations.  (5 points)

b)  Some people, say, group 1, suggest the increasing use of artificial intelligence (AI) may have an (immediate) adverse impact on real wages, as the integration of AI into the production process has led to job redundancies.  However, another group of people, say, group 2, argue that over time (i.e., in the very long run) the impact on real wages would be a wash, as businesses begin to reap the benefits of their investment in AI technology.   Using the neoclassical theory  of distribution and ONE labour market diagram, explain how the arguments presented by both group 1 and group 2 could be correct.  (10 points)

Note: All submitted diagrams must be drawn by hand (i.e., you  are NOT allowed to use any drawing/diagramming tools or software).   However,  you  may hand draw the diagrams on your tablet(s).  Failure to submit hand-drawn diagrams will result in a grade of ZERO for this part of the question.

c)   Suppose  the  growth  rates  of the  labour  force  and  the  physical  capital  stock  are  5%  and  2%, respectively,  and  the  labour  share  of income  is  75%.    In  addition,  total  factor  productivity  is increasing at 1%.  If the velocity of money is rising at 1% and the central bank wants to target an

inflation rate of 2%, what monetary growth rate should the central bank set?  (5 points) Note:  All the growth rates are annual rates.  Keep your answers to 4 decimal places.

d)  Use the quantity equation to explain the effect of an improvement in payment technology, such as the increasing use of mobile payment apps on the long-run levels of output, velocity of money, and price level.  (5 points)