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Unformatted text preview: Economics 304L: Principles of Macroeconomics Spring 2010 Sadler Homework 4 Solutions The following problems refer to the “Problems and Applications” section at the end of Chapter 15 of Mankiw (pp. 332 ‐ 333). 1. No. 4 This question is intended to help you understand the fact that not all new employment is due to the fact that the unemployed have become employed. The labor force can grow due to population growth and growth in labor force participation. During a period of economic expansion like 2004 – 2007 (not a strong expansion, granted), the number of unemployed people would be declining as they find jobs (increasing employment). At the same time, new entrants to the labor force would also be causing employment to expand. Thus, the fact that employment increased 6.8 million while unemployment declined 1.1 million is consistent with growth in the labor force of 5.7 million workers. The labor force constantly increases as the population grows and as labor‐force participation increases, so the increase in the number of people employed may always exceed the reduction in the number unemployed. 2. No. 5 a. If an auto company goes bankrupt and its workers immediately begin looking for work, the unemployment rate will rise and the employment‐population ratio will fall. b. If some of the unemployed auto workers give up looking for a job, the unemployment rate will fall and the employment‐population ratio will remain the same. c. If numerous students graduate from college and cannot find work, the unemployment rate will rise and the employment‐population ratio will remain unchanged. d. If numerous students graduate from college and immediately begin new jobs, the unemployment rate will fall and the employment‐population ratio will rise. e. If a stock market boom induces earlier retirement, the unemployment rate will rise and the employment‐population ratio will fall. f. Advances in health care that prolong the life of retirees will not affect the unemployment rate and will lower the employment‐population ratio. 3. No. 7 Economics 304L: Principles of Macroeconomics Spring 2010 Sadler The figure below shows a diagram of the labor market with a binding minimum wage. At the initial minimum wage (m1), the quantity of labor supplied L1S is greater than the quantity of labor demanded L1D, and unemployment is equal to L1S − L1D. An increase in the minimum wage to m2 leads to an increase in the quantity of labor supplied to L2S and a decrease in the quantity of labor demanded to L2D. As a result, unemployment increases as the minimum wage rises. 4. a. No. 8 The figure below illustrates the effect of a union being established in the manufacturing labor market. In the figure on the left, the wage rises from w1U to w2U and the quantity of labor demanded declines from U1 to U2D. Because the wage is higher, the quantity supplied of labor increases to U2S, so there are U2S − U2D unemployed workers in the unionized manufacturing sector. When those workers who become unemployed in the manufacturing sector seek employment in the service labor market, shown in the figure on the right, the supply of labor shifts to the right from S1 to S2. The result is a decline in the wage in the nonunionized service sector from w1N to w2N and an increase in employment in the nonunionized service sector from N1 to N2. b. Economics 304L: Principles ofMacroeconomics Spring 2010 Sadler The following problems refer to the “Problems and Applications” section at the end of Chapter 13 of Mankiw (pp. 291 ‐ 292). 5. No. 3. Use a model of loanable funds for developing countries (or “emerging markets”) to explain your answer. First of all, when a company or government defaults on its debt to investors, it means that investors can expect to receive none of the principal or interest that they were owed. When the Russian government defaulted on its debt, investors perceived a higher chance of default (than they had before) on similar bonds sold by other developing countries. An increase in risk reduces investors willingness to supply funds at every given interest rate. Thus, the supply of loanable funds to emerging markets such as Russia shifted to the left, as shown in the figure below, which is intend as a model of loanable funds to emerging markets. The result was an increase in the interest rate on funds in emerging market, which is exactly what happened in reality following the Russian default. 6. No. 6 Given that Y = 8, T = 1.5, Sprivate = 0.5 = Y −T − C, Spublic = 0.2 = T − G. Because Sprivate = Y − T − C, then rearranging gives C = Y − T − Sprivate = 8 − 1.5 − 0.5 = 6.0 Because Spublic = T − G, then rearranging gives G = T − Spublic = 1.5 − 0.2 = 1.3 Because S = national saving = Sprivate + Spublic = 0.5 + 0.2 = 0.7 Finally, because I = investment = S, I = 0.7 Economics 304L: Principles of Macroeconomics Spring 2010 Sadler 7. No. 7 Private saving is equal to (Y – C – T) = 10,000 – 6,000 – 1,500 = 2,500 Public saving is equal to (T – G) = 1,500 – 1,700 = ‐200 National saving is equal to (Y – C – G) = 10,000 – 6,000 – 1,700 = 2,300 Investment is equal to saving = 2,300 The equilibrium interest rate is found by setting investment equal to 2,300 and solving for r: 3,300 – 100r = 2,300 100r = 1,000 r = 10 % 8. No. 9 a. The figure below illustrates the effect of the $20 billion increase in government borrowing. Initially, the supply of loanable funds is curve S1, the equilibrium real interest rate is i1, and the quantity of loanable funds is L1. The increase in government borrowing by $20 billion reduces the supply of loanable funds at each interest rate by $20 billion, so the new supply curve, S2, is shown by a shift to the left of S1 by exactly $20 billion. As a result of the shift, the new equilibrium real interest rate is i2. The interest rate has increased as a result of the increase in government borrowing. b. Because the interest rate has increased, investment and national saving decline and private saving increases. The increase in government borrowing reduces public saving. From the figure you can see that total loanable funds (and thus both investment and national saving) decline by Economics 304L: Principles of Macroeconomics Spring 2010 Sadler less than $20 billion, while public saving declines by $20 billion and private saving rises by less than $20 billion. c. The more elastic is the supply of loanable funds, the flatter the supply curve would be, so the interest rate would rise by less and thus national saving would fall by less, as shown below. d. The more elastic the demand for loanable funds, the flatter the demand curve would be, so the interest rate would rise by less and thus national saving would fall by more, as shown below. e. If households believe that greater government borrowing today implies higher taxes to pay off the government debt in the future, then people will save more so they can pay the higher future taxes. Thus, private saving will increase, as will the supply of loanable funds. This will offset the reduction in public saving, thus reducing the amount by which the equilibrium quantity of investment and national saving decline, and reducing the amount that the interest rate rises. If the rise in private saving was exactly equal to the increase in government borrowing, there would be no shift in the national saving curve, so investment, national saving, and the interest rate would all be unchanged. This is the case of Ricardian equivalence. ...
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This note was uploaded on 12/17/2010 for the course ECO 33530 taught by Professor Sadler during the Spring '10 term at University of Texas at Austin.
- Spring '10