anshw1 2007

# Macroeconomics plus MyEconLab plus eBook 1-semester Student Access Kit (6th Edition)

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Econ 304 Sonoma State University Fall 2007 Dr. Robert Eyler Suggested Answers to Homework #1 1. a. Explain the connection between the definition of GDP according to the “expenditures” approach, and the circular flow of the economy. The expenditures approach to measuring GDP is defined by the following equation: Y = C + I + G + NX where NX = EX – IM and GDP = Y. The expenditures are by the household (C), the firm (I), the government (G), and the international sector in net (EX – IM). Because the circular flow of the macroeconomy is based on these four entities: households, firms, government and the international sector, these expenditures aggregate the economic activity of the macroeconomy. b. Discuss the difference between real and nominal economic variables, and why real variables are the focus of macroeconomic analyses by discussing GDP and interest rates in both forms. Real and nominal variables are different in that real variables are nominal variables after price effects are removed. For example, if a worker’s wage is \$20 an hour, this is the worker’s nominal wage. If the inflation rate is 5% annualized, the worker’s real wage is 5% less than their nominal wage = \$19.04. Wage Real 100 x Index Price Wage Nominal = = \$19.04 100 x 105 \$20 = There is a slightly different calculation for the real interest rate. Because the interest rate is a percentage growth figure (the percent at which a financial investment rises in value while invested), instead of dividing by a price index, subtract the inflation rate instead. For example, suppose \$1000 is invested at 5% compounded one time annually and held for one year. The nominal rate of interest is 5%, and the investor would receive \$1,050 in one year. If the inflation rate is 3%, the real interest rate is only 2% as the investor will lose \$30 of her return to higher prices. Economists focus on real variables because they drive economic activity. 2. When the labor market is in equilibrium, macroeconomists consider the economy to be in “full employment”.

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a. Explain the two ways of becoming unemployed, involuntary and voluntary. Involuntary unemployment is when the worker is chosen to be unemployed or is fired. The firm makes this decision based on the wage being paid to the worker and the marginal productivity of the worker. When MPL < w, the firm has an incentive to reduce the labor hours for the worker, where w is the real wage and MPL is the marginal product of labor. Voluntary Unemployment is when the worker chooses to be unemployed or quits. The worker makes this decision because he believes that the wage he is paid is less than his marginal productivity level. When MPL > w, the worker has an incentive to quit. b. Explain how each of unemployment’s four classic types are all involuntary unemployment. The classic types of unemployment are as follows: 1. Seasonal : The firm chooses to lay workers off because of the time of year. Some examples are ski instructors, field workers in agriculture, etc.
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