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Assignment 3 Macro

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Assignment 3 Macro

Uploaded by

Vir Sethi
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© © All Rights Reserved
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Download as PDF, TXT or read online on Scribd
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Intermediate Macro

Assignment 3

1. Suppose that an economy is characterized by the following production function:

𝑌=2 𝐾 𝑁

a. Derive the steady-state level of output per worker, and the steady-state level of capital
per worker in terms of the saving rate, s, and the depreciation rate, δ.

b. Derive the equation for the steady-state level of consumption per worker in terms of
the saving rate, s, and the depreciation rate, δ.

c. At what rate does capital per worker grow in the steady state?

d. What happens to the steady state level of capital per worker, output per capita when
the savings rate increases? Would you recommend increasing the savings rate to 90%
of total income?

e. What happens to the steady state level of consumption per worker.

f. Compute the golden rule level of capital for this economy.

g. Think about the above model and assume that now there is technological progress that
grows at rate gA. Write down the formula for the steady state level of capital per
effective worker. In the steady state at what rate is the capital per effective worker
growing. How about capital per worker?
(Bonus: represent the balanced growth path equilibrium using a graph similar to 12.2
in page 262 in the textbook, but in terms of capital per worker, not capital per
effective worker )

2. List and briefly describe the components of the Current Account. Write down an
example (provide a table) that features a current account deficit, such that exports are
higher than imports and net exports are positive. Is this possible?
3. Each of the governments of Switzerland and Italy has issued bonds in CHF and EUR
respectively. Assume that both government securities are one-year bonds, i.e., paying
the face value of the bond one year from now. Suppose that the exchange rate, E,
stands at 1 Euro per 0.9 CHF.
The following table gives face values and prices of both bonds:

Face Value Price


Italy EUR 10,000 9700
Switzerland CHF 10,000 9400

a. Compute the nominal interest rate on each of the bonds.

b. Compute the expected exchange rate next year consistent with uncovered interest
parity.

c. Assuming the interest rate parity condition does not hold and you expect the EURO to
depreciate relative to the CHF, which bond should you buy?

4. Policy coordination and the world economy.


Consider an open economy in which the real exchange rate is fixed and equal to one.
Consumption, investment, government spending, and taxes are given by:

C = 8 + 0.5(Y – T), I = 8, G = 8, and T = 8


Imports and exports are given by
IM = 0.2 Y and X = 0.2 Y *
where Y* denotes foreign output.

a. Solve for equilibrium output in the domestic economy, given Y*. What is the
multiplier in this economy?
b. If we were to close the economy—so that exports and imports were identically equal
to zero—what would the multiplier be? Why would the multiplier be different in a
closed economy?

c. Assume that the foreign economy is characterized by the same equations as the
domestic economy (with asterisks reversed). Use the two sets of equations to solve for
the equilibrium output of each country. (Hint: Use the equations for the foreign
economy to solve for Y * as a function of Y and substitute this solution for Y * in part
a.) What is the multiplier for each country now? Why is it different from the open
economy multiplier in part a?

d. Assume that the domestic government, G, has a target level of output of 125.
Assuming that the foreign government does not change G *, what is the increase in G
necessary to achieve the target output in the domestic economy? Solve for net exports
and the budget deficit in each country.

e. Suppose each government has a target level of output of 125 and that each
government increases government spending by the same amount. What is the
common increase in G and G * necessary to achieve the target output in both
countries? Solve for net exports and the budget deficit in each country.

5. Multipliers, openness, and fiscal policy


Consider an open economy characterized by the following
equations:
C = c0 + c1(Y - T)
I = d0 + d1 Y
IM = m1*Y
X = x1*(Y*)
The parameters m1 and x1 are the propensities to import and export. Assume that the real
exchange rate is fixed at a value of 1 and treat foreign income, Y*, as fixed. Also assume that
taxes are fixed and that government purchases are exogenous (i.e., decided by the
government). We explore the effectiveness of changes in G under alternative assumptions
about the propensity to import.

a. Write the equilibrium condition in the market for domestic goods and solve for Y.
b. Suppose government purchases increase by one unit. What is the effect on output?
(Assume that 0 <m1 <c1 + d1< 1. Explain why.)

c. How do net exports change when government purchases increase by one unit?

Now consider two economies, one with m1 = 0.5 and the other with m1 = 0.1. Each economy
is characterized by (c1 + d1) = 0.6.

d. Suppose one of the economies is much larger than the other. Which economy do you
expect to have the larger value of m1 ? Explain.

e. Calculate your answers to parts b and c for each economy by substituting the appropriate
parameter values.

f. In which economy will fiscal policy have a larger effect on output? In which economy will
fiscal policy have a larger effect on net exports?

6. The Marshall Lerner Condition


a. Assume that the Marshall Lerner condition does not hold. In fact assume that a real
depreciation leads to a decrease in net exports.
Represent this effect in using a figure equivalent to figure 18-4 in page 400 of the
textbook.

b. What happens to equilibrium output?


7. Policy Mix
a. If the economy exhibits low output and a trade deficit and wants to keep
output low, but reduce the trade deficit. What policy mix should it implement?
(In this case refer to a policy mix between exchange rate policy and fiscal
policy)

b. If the economy exhibits high output and a trade deficit and wants to keep
output high, but reduce the trade deficit. What policy mix should it
implement?
(In this case refer to a policy mix between exchange rate policy and fiscal
policy)

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