Answerall:

Questions.,,

Consider an economy where consumers spend C, businesses invest I, and there is no government for simplicity (TR = T = 0).

In this economy we can write Consumption as: = + MPCGDP The economy also imports some amount of goods, but it does not export anything. We can represent imports (M) by the following: = + MPCF DP where MPCF can be thought of as the marginal propensity to consume foreign goods and F is the amount of imports that will occur even with no disposable income.

(a) What is the total aggregate expenditure equation in this economy? What is the equilibrium condition? Solve for GDP* as a function of all other variables. Is the spending multiplier larger or smaller than our typical spending multiplier?

Why is it larger or smaller?

Explain the intuition behind the results. Is the spending multiplier larger or smaller than 1?

Why is it larger or smaller?

Explain the intuition behind the results.

Exercise 11.1 Use a diagram to illustrate an economy at the equilibrium inflation rate. In this diagram, show how a permanent increase in exports would affect the equilibrium inflation rate and the equilibrium level of GDP if the central bank did not react and change its monetary policy. Exercise 11.2 Suppose the central bank reacted to defend its inflation target from the effect of the increase in exports in Exercise 11.1. Use an ADx/ASa diagram to show the change in the equilibrium interest rate setting and real GDP you would observe. Exercise 11.3 Suppose opportunities for investing in high tech applications boost aggregate de- mand in the short run, and aggregate supply in the long run. Using ASat and ADa curves with equilibrium at potential output, show why output might rise in the long run without much of an increase in inflation. Exercise 11.4 Suppose a new round of labour negotiations results in a higher average rate of increase in money wage rates for the next three years. Illustrate and explain how this would affect short-run aggregate supply conditions and the ASa curve. Exercise 11.5 Draw an aggregate supply and demand curve diagram to show an economy in short- run equilibrium at potential output. Suppose a wide-spread recession reduces incomes in foreign countries, leading to reduced demand for exports. Illustrate and explain how this would affect the short-run equilibrium Y and a in your diagram. Exercise 11.6 Suppose central banks have reduced their policy interest rates to the lower bound to fight a deep and prolonged recession. Use a diagram to show how either a reduction in the inflation rate, or deflation, would change the slope of the ADa curve. Would cuts in nominal money wage rates and further reductions in the inflation rate reduce the recessionary gap when the central bank is constrained by the lower bound on its interest rate? Exercise 11.7 In the two years before 2008 the Canadian federal government reduced the GST from 7 percent to 5 percent. Use an ADx/ASat/Yp diagram to illustrate and explain the effects of this tax change on equilibrium output and inflation. If the economy was in equilibrium at Yp and the target inflation rate at" before the tax cut, what monetary policy action, if any, would the central bank make to maintain those equilibrium conditions after the tax cut? What short-run net benefit, if any, would households and businesses realize as a result of the cut in the GST? Exercise 11.8 Define the "public debt' and explain why and how it might increase from one year to the next. 302 . Inflation, real GDP, monetary policy & fiscal policy Exercise 11.9 Would it be possible for the ratio of the public debt to GDP (PD/Y) to fall even if the government's primary budget is in deficit? Explain your answer. Exercise 11.10 Would it be possible for the ratio of public debt to GDP (PD/Y) to rise even if the government's primary budget balance is in surplus? Explain your answer. Exercise 11.11 Optional: Suppose the central bank's monetary policy sets the interest rate accord- ing to the function: i = 3.0+2.0(x - >") with a" = 4.0, and aggregate expenditure is the sum of: C= 200+0.75Y 1 = 85 -27 G = 100 X - IM =50-0.15Y - 3i (a) What is the equation for the ADa curve? (b) Plot the AD curve in a diagram, not necessarily to scale, that shows the horizontal intercept and slope of the curve.Exercise 6.1 Suppose that in an economy with no government the aggregate expenditure function is: AE = 50 +0.75Y. (a) Draw a diagram showing the aggregate expenditure function, and indicate the level of planned expenditure when income is 150 (b) In this same diagram, show what would happen to aggregate expenditure if income increased to 200. (c) What are the levels of autonomous expenditure and induced expenditure at income levels of 150 and 200. (d) In this same diagram show what would happen if autonomous expenditure increased by 20. Exercise 6.2 Suppose the media predicts a deep and persistent economic recession. Households expect their future income and employment prospects to fall. They cut back on expenditure, re- ducing autonomous expenditure from 50 to 30. (a) Re-draw the aggregate expenditure functions you have drawn in your diagrams for Exer- cise 6.1 to show the effects, if any, of this change in household behaviour. (b) Suppose the negative economic forecast also reduces induced expenditure in the economy from 0.75Y to 0.5Y. In a diagram show the effect would this have on the aggregate expendi- ture functions you have drawn. Exercise 6.3 Construct a table showing autonomous, induced and aggregate expenditure at differ- ent income levels (Y) for an economy with autonomous expenditure of 105 and induced expendi- ture of 0.5Y. (a) Using numbers from your table draw a diagram showing the aggregate expenditure function AE. What is the intercept of this function on the vertical axis? (b) What is the slope of the AE function, and what does the slope measure? (c) Write the equation for the aggregate expenditure function for this economy. Exercise 6.4 Output and income are in equilibrium when planned expenditures AE are equal to national income, Y', in other words, meaning Y = AE. (a) Suppose the AE function is AE = 175 +0.75Y. Draw a diagram showing the aggregate expenditure function. (b) In your diagram draw the 45 line that shows all points at which national income and aggre- gate expenditures are equal (Y = AE).QUESTION 3: (30 points) For the Solow model with human capital: a) Write the aggregate production function with human capital in terms of per effective worker variables. b) Derive an expression for the growth rate of output per worker and discuss the three sources of growth. c) Write the equations of the complete model. d) Derive the two Solow equations for the model. e) Solve for the steady state values of output per effective worker, physical capital per effective worker, and human capital per effective worker. f) Derive the steady state paths for output per worker and consumption per worker. g) Draw the Phase diagram for the Solow model with human capital