Macroeconomics(Tenth Edition)Rudiger Dornbusch, Stanley Fisher, Richard StartsCHAPTER 1 INTRODUCTIONConceptual Problemsing the aggregate supply-aggregate demand model explain how output and price are determined. Will output vary or stay fixed in the long run? Suppose the aggregate demand curve were to remain fixed: what can we infer about the behavior of prices over time?Answer:The way output and prices are determined in the aggregate can be analyzed most easily using the AD-AS model; however, we have to determine first which time frame we have in mind.The vertical AS-curve describes the very long run and output is determined by aggregate supply alone while the price level is determined by the level of aggregated demand relative to the output the economy can supply.The horizontal AS-curve describes the very short run and output is determined by aggregate demand alone while the price level is fixed and unaffected by changes in output.The upward-sloping AS-curve describes the medium run and fluctuations in aggregate supply or aggregate demand can determine actual output and the price level under the assumption that productive capacity is given.The AD-AS framework is a very simplified representation of the real world that cannot describe the behavior of all people and enterprises in an economy. In this framework, the effects of changes in aggregate demand on output and prices depend largely on the slope of the AS-curve. We should keep in mind that the long-run AS-curve tends to shift to the right from year to year as potential output tends to grow. Therefore, even in the unlikely event that the AD-curve remains fixed, the price level would change, that is, decline over time.Technical Problems1.Suppose that actual output is $120 billion and potential (full-employment) output is $156 billion. What is an output gap in this hypothetical economy? Based on your estimate of the output gap, would you expect the unemployment level to be higher or lower than usual?Answer：The textbook defines the output gap as the difference between actual GDP and potential GDP. Therefore the output gap in this hypothetical economy is -$36 billion. Since actual output falls short of potential output, we should expect the unemployment rate to be higher than usual.Chapter 2 National Income AccountingConceptual Problems1.what would happen to GDP if the government hired unemployed workers, who had been receiving amount $TR in unemployment benefits, as government employees and now paid the2.m $TR to do nothing? Explain.Answer:Government transfer payments (TR) do not arise out of any production activity and are thus not counted in the value of GDP. If the government hired the people who receive transfer payments, then their wages would be counted as part of government purchases (G), which is counted in GDP. Therefore GDP would rise even if these workers were paid to do nothing, as government purchases are measured on a cost basis.Technical Problems8.Suppose you buy a $100 government bond that is due next year. How much nominal interest will you receive if inflation is 4 percent over the year and the bond promises a real return of 3 percent?Answer:The real interest rate (r) is defined as the nominal interest rate (i) minus the rate of inflation (π). Therefore the nominal interest rate is the real interest rate plus the rate of inflation, ori = r + π = 3% + 4% = 7%.Chapter 3 Growth and AccumulationConceptual2. Can the Solow growth model help to explain the phenomenon of convergence? Answer:The Solow model predicts convergence, that is, countries with the same production function, savings rate, and population growth will eventually reach the same level of income per capita. In other words, a poor country may eventually catch up to a richer one by saving at the same rate and making technological innovations. However, if these countries have different savings rates, they will reach different levels of income per capita, even though their long-term growth rates will be the same.Technical9.For a Cobb-Douglas production function Y=AKθN（1-θ），verify that 1-θis labor’s share of income.[Hint: Labor’s share of income is the piece of income which results from that labor(MP L×N)divided by total income. ]Answer:The Cobb-Douglas production function is defined asY = F(N,K) = AN1-θKθ.The marginal product of labor can then be derived asMPN = (∆Y)/(∆N) = (1 - θ)AN-θKθ = (1 - θ)AN1-θKθ/N = = (1 - θ)(Y/N)==> labor's share of income = [MPN*(N)]/Y = (1 - θ)(Y/N)*[(N)/(Y)] = (1 - θ) Chapter 4 Growth and PolicyConceptual1.What is endogenous growth? How do endogenous growth models differ from the neoclassical models of growth presented in Chapter 3?Answer:Endogenous or self-sustained growth supposedly can be achieved by policies that affect a nation's savings rate and therefore the proportion of GDP that goes towards investment. The neoclassical growth model of Chapter 3 predicted that long-term growth can only be achieved through technological progress and that changes in the savings rate have only transitory effects. The endogenous growth model, however, predicts that countries with a higher savings rate can achieve higher long-term growth and that a nation's government can affect the long-term growth rate by implementing policies that affect the savings rate.2. Why doesn’t the constant marginal poduct of capital assumed in this chapter’s simple model of endogenous growth create a situation in which a single large firm dominaties the economy, as traditional microeconomic reasoning would suggest?Answer:A simple model with constant returns to scale to capital alone implies increasing returns to scale to all factors taken together, which could cause a single large firm to dominate the economy. However, such a model ignores the possibility that external returns to capital exist, in addition to the internal (private) returns. In other words, more investment not only leads to a higher and more efficient capital stock but also to new ideas and new ways of doing things, which can then be copied by others. Therefore, a single firm does not necessarily reap all of the benefits of increased output.Chapter 5 Aggregate supply and demandConceptual2. Explain why the calssical supply curve is vertical. What are the mechanisms that ensure continued full employment of labor in the calssical case?Answer:The classical aggregate supply curve is vertical, since the classical model assumes that nominal wages always adjust immediately to changes in the price level. This implies that the labor market is always in equilibrium and output is always at the full-employment level. If the AD-curve shifts to the right, firms try to increase output by hiring more workers, and they try to attract them by offering higher nominal wages. However, since we are already at full employment, the overall work force does not increase, so firms merely bid up nominal wages. The nominal wage increase is passed on in the form of higher product prices. Since the level of wages and prices will have increased proportionally, the real wage rate and the levels of employment and output will remain unchanged.If there is a decrease in demand, workers are willing to accept lower nominal wages to stay employed. Lower wage costs enable firms to lower their prices, and ultimatelynominal wages and prices decrease proportionally while the real wage rate and the levels of employment and output remain the same.Technical2. Suppose that the government increases spending from G to G’while simultaneously raising taxes in such a way that, at the initial level of output, the budget remains balanced.a. Show the effect of this change on the aggregate demand schedule.b. How does this affect output and the price level in the Keynisian case?c. How does this affect output and the price level in the classical case? Answer:a. According to the balanced budget theorem, a simultaneous and equal increase in government purchases and taxes will shift the AD-curve to the right, as the positive impact of the increase in government spending is greater than the negative impact of the tax increase. But if the AS-curve is upward sloping, then the balanced budget multiplier will be less than one, that is, the increase in output will be less than the increase in government purchases. This occurs because part of the fiscal expansion will be crowded out, that is, the level of private spending will decrease, due to a higher price level, lower real money balances, and the resulting rise in interest rates.b. In the Keynesian case, the AS-curve is horizontal and the price level remains unchanged. There is no real balance effect and therefore income increases more than in 2.a., that is, output increases by the whole shift in the AD-curve. However, the interest rate still increases and therefore the balanced budget multiplier is less than one (but greater than in 2.a.).c. In the classical case, the AS-curve is vertical and the output level remains unchanged. In this case, a shift in the AD-curve leads to a price increase and real money balances decline. Therefore interest rates increase further than in 2.b. or even 2.a., leading to full crowding out of investment. Hence the balanced budget multiplier is zero in the classical case.Chapter 6 Aggregate Supply: Wages, Prices, and UnemploymentConceptual1.Explain how the aggregate supply and Phillips curves are related to each other. Can any information be derived from one that cannot be derived from the other? Answer:The aggregate supply curve and the Phillips curve describe very similar relationships and both curves can be used to analyze the same phenomena. The AS-curve shows a relationship between the price level and the level of output, while the Phillips curve shows a relationship between the inflation and unemployment rates. For example, a movement along the upward-sloping AS-curve depicts an increase in the price level that is associated with an increase in the level of output. But Okun’s law states that changes in output and the rate of unemployment are tightly linked. Therefore, with an increase in the price level (a higher level of inflation) there will be a higher level of output (a lower level of unemployment). Thus the AS-curve is upward sloping while the Phillips curve is downward-sloping. This downward-sloping Phillips curve shifts whenever inflationary expectations change. If one assumes that workers will change their wage demands whenever their inflationary expectations change, one can conclude that a shift in the Phillips curve corresponds to a shift in the upward-sloping AS-curve, since higher wages imply a higher cost of production.The simple AD-AS diagram depicts a static framework, which relates changes in the price level to changes in output supplied or demanded. The Phillips-curve, on the other hand, depicts a dynamic framework in which percentage price changes (the rate of inflation) are related to changes in the unemployment rate. Along the short-run Phillips-curve inflationary expectations are assumed to be constant. If one assumes that price expectations are constant along the upward-sloping AS-curve, the AD-AS framework becomes even more compatible with the Phillips curve framework.CHAPTER 7 THE ANATOMY OF INFLATION AND UNEMPLOYMENT1.Discuss how the following changes would affect the natural (or frictional) rate of unemployment:a. Elimination of unionsb. Increased participation of teenagers in the labor market.Answer:a. It is unclear whether the elimination of unions would actually serve to reduce the natural rate of unemployment. The insider-outsider theory of the labor market suggests that firms bargain with unions (the insiders) and are not much concerned with the unemployed (the outsiders). If unions were eliminated, firms would tend to hire unemployed workers at a lower wage rate, thus reducing the natural unemployment rate. On the other hand, unions tend to preserve stable jobs for their members. Eliminating unions could lead not only to a reduction in bargaining power for labor in wage negotiations but also to an increase in the natural rate of unemployment. If labor unions were eliminated, the wage differentials between unionized and non-unionized workers would disappear and, in the process, some income would be redistributed.b. Increased labor force participation of teenagers would at least initially increase the natural rate of unemployment, since teenagers have a higher frequency of unemployment than older, more experienced workers. However, as more and more teenagers entered the labor force and more good and stable jobs became available to them, the natural rate of unemployment would start to decline again. With more people in the labor force, the supply of labor would be higher and wage rates would be driven down, contributing to wage stagnation.2. The following information is to be used for calculations of the unemployment rate: Suppose there are two major groups, adults and teenagers, with adults divided into men and women. Teenagers account for 10 percent of the labor force; adults account for 90 percent. Women make up 35 percent of the adult labor force. Suppose also that the unemployment rates for these groups are follows: teenagers, 19 percent; men, 7 percent; women, 6 percent.a. Calculate the aggregate unemployment rate.b. What if the share of teenagers in the labor force increases from 10 to 15 percent. How will this affect the aggregate unemployment rate?Answer:a. The aggregate unemployment rate can be calculated by adding the unemployment rates of different groups weighted by their share of the labor force. The data in the problem indicate that teenagers constitute 10% of the labor force. The adult work force (the other 90%) is divided into 35% females and 65% males. Thus we can calculate the overall unemployment rate as:u = (0.1)(0.19) + (0.9)[(0.35)(0.06) + (0.65)(0.07)] = 0.019 + (0.9)(0.021 + 0.0455)= 0.019 + 0.05985 = 0.07885 = 7.9%.b. If the labor force participation rate of teenagers increases to 15%, the overall unemployment rate changes to:u1 = (0.15)(0.19) + (0.85)[(0.35)(0.06) + (0.65)(0.07)]= 0.0285 + (0.85)(0.021 + 0.0455)= 0.0285 + 0.056525 = 0.085025 = 8.5%.CHAPTER 8 POLICY PREVIEW1. How does the Taylor rule help a central bank to set interest rates? How could this rule be adapted if the central bank decided to follow a policy of pure inflation targeting?Answer：The Taylor rule serves as a guide for a central bank on how to set the nominal interest rate in response to current economic conditions. Specifically it states that:i t = r*+ πt+ α*( πt - πt*) + β*[100* (Y t - Y t* )/Y t* ]and suggests that if the inflation rate goes above the inflation target rate π* set by t he central bank or if output goes above the full-employment level Y*, the central bank should raise interest rates . Clearly, the larger the size of the coefficients α and β, the more aggressively the central bank should respond to a change in either inflation or output. If the coefficient β is set to β = 0, the Taylor rule corresponds to strict inflation targeting, in which changes in output are ignored while the central bank still responds to changes in the inflation rate.2. Assume output is currently 1.6% below its full-employment level and the inflation rate is3.5%. Assume further that the central bank has specified that the inflation coefficient is α = 0.5 and that the “natural real interest rate” is assumed to be 2%. At what level should the central bank set the nominal interest rate if it wants to enforce a strict inflation target of 2.5%?Answer：The Taylor rule suggests that a central bank sets the nominal interest rate in the following way:i t = r*+ πt+ α*( πt - πt*) + β*[100* (Y t - Y t* )/Y t* ]Strict inflation targeting suggests that the output coefficient is set to β = 0, so it does not matter how far GDP is below its potential. However, if the current inflation rate is 3.5%, then according to the Taylor rule the central bank should set the nominal interest rate at 6%, sincei t = 2 + 3.5 + 0.5*(3.5 – 2.5) = 5.5 + 05*(1) = 6.。