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Unformatted text preview: Econ 73-200 Fall 2008 Prof. Daniele Coen-Pirani Suggested Answers to Problem Set #3 As indicated on Blackboard, this problem set is due on Friday, October 24, at the end of your recitation session. Please consult the syllabus on the policy for homework assignments handed in late. There are four questions on the homework worth a total of 100 points. The points assigned to each part of each question are indicated in brackets. Please staple the sheets of your homework together (I decline responsibility for missing homework sheets, if not stapled). You may work together to solve the exercises, but must write your own answers (in your own words) to each problem. Exercise #1 [25 pts.]. Read the following excerpt from Casey Mulligan&s blog: There are two shocks supposedly hitting the non-nancial sector (which is most of our economy) as a result of the banking crisis. One of them is an adverse saver-investor intermediation shock. That is, the return to saving is low even while the cost of borrowing is high. The second shock is one of "condence" (and also recognition that the stock market has crashed) an adverse wealth e/ect on consumption and leisure. These two shocks have exactly the opposite e/ects, which is why I am much less condent than the rest of America that GDP will fall as a result of the last month&s events. Intermediation Shock I have argued that the intermediation shock is not that large, and at worst short-lived, because the entry motive pushes toward reducing that shock. Nev- ertheless, I will analyze it as if it were quantitatively important. By itself, this shock INCREASES consumption, because the alternative (saving) does not look as attractive. It decreases investment and raises the marginal product of capital because the cost of capital is temporarily high. Capital is xed in the short run, so any e/ect on GDP has to come from labor supply or productivity. Labor supply should fall due to an intertemporal substitution e/ect (i.e., working hard is one way to save, but now is, according to the theory, not a good time to save). This e/ect may not be large, because there are other intertemporal substitution e/ects to worry about... Productivity will be down somewhat, only because the banking sector is terribly unproductive and the banking sector is part of the aggregate. So the intermediation e/ect will reduce output in the short term, but increase output post-crisis above what it would have been absent the crisis. Wealth E/ect Owners of equities are undoubtably poorer now than they were a year ago. Even persons who do not own equities may fear an eventual reduction in their 1 labor income. This INCREASES labor supply, DECREASES consumption, and increases investment (with an ambiguous e/ect on the marginal product of capi- tal). For example, baby boomers may delay their retirement because their 401k values no longer a/ord them as comfortable a retirement. This increases output now, and post-crisis compared to what it had been absent the crisis.now, and post-crisis compared to what it had been absent the crisis....
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This note was uploaded on 01/20/2012 for the course INVESTMENT 101 taught by Professor Unknown during the Spring '08 term at Carnegie Mellon.
- Spring '08