Summer 2014 Week 7 Tutorial Questions Solutions (Ch5&6)

Transcription

1 Chapter 5: Q1: Macroeconomics P.178 Numerical Problems #4 Q2: Macroeconomics P.179 Analytical Problems #5 Chapter 6: Q3: Macroeconomics P.220 Review Questions #6 Q4: Macroeconomics P.220 Review Questions #7 Q1: Consider two large open economies, the home economy and the foreign economy. In the home country the following relationships hold: Desired consumption, C d = (Y T) 200r w ; Desired investment, I d = r w Output, Y = 1000 Taxes, T = 200 Government purchases, G = 275 In the foreign country the following relationships hold: Desired consumption, C For = (Y For T For ) 300r w Desired investment, I For = r w Output, Y For = 1500 Taxes, T For = 300 Government purchases, G For = 300. a. What is the equilibrium interest rate in the international capital market? What are the equilibrium values of consumption, national saving, investment, and the current account balance in each country? To find the equilibrium interest rate (r w ), we must first calculate the current account for each country as a function of r w. Then we can find the value of r w that clears the goods market, that is, where CA + CA For = 0. Home: Week 7 Page 1

2 C d = ( ) 200 r w = r w = r w CA = NX = S d I d = Y (C d + I d G) = 1000 ( r w r w + 275) = r w Foreign: C For = ( ) 300 r w = r w CA For = NX For = S For I For = Y For (C For + I For + G For ) = 1500 ( r w r w + 300) = r w At equilibrium, CA + CA For = 0, so: r w r w = r w = 0 r w =0.05 C = r w = 630 C For = r w = 945 S = Y C G = = 95 S For = Y For C For G For = = 255 I = r w = 140 I For = r w = 210 CA = S I = = 45 CA For = S For I For = = 45 b. Suppose that in the home country government purchases increase by 50 to 325. Taxes also increase by 50 to keep the deficit from growing. What is the new equilibrium interest rate in the international capital market? What are the new equilibrium values of consumption, national saving, investment, and the current account balance in each country? C d = ( ) 200 r w = r w = r w Week 7 Page 2

3 CA = NX = S d I d = Y (C d + I d + G) = ( r w r w + 325) = r w At equilibrium, CA + CA For = 0, so: r w r w = r w = 0 r w = 0.08 C = r w = 604 C For = r w = 936 S = Y C G = = 71 S For = Y For C For G For = = 264 I = r w = 134 I For = r w = 201 CA = S I = = 63 CA For = S For I For = = 63 So a balanced-budget increase in government spending increases the home country's current account deficit. Q2: How would each of the following affect national saving, investment, the current account balance, and the real interest rate in a large open economy? a). An increase in the domestic willingness to save (which raises desired national saving at any given real interest rate). The home country's saving curve shifts to the right, from S 1 to S 2. The real world interest rate falls, so that the current account surplus in the home country equals the current account deficit in the foreign country. S rises, I rises, CA rises, r w falls. Week 7 Page 3

4 b). An increase in the willingness of foreigners to save. The foreign country's saving curve shifts to the right, from S 1For to S 2For The real world interest rate must fall, so the current account surplus in the foreign country equals the current account deficit in the home country. As shown in the figure, S falls, I rises, CA falls, r w falls. c). An increase in foreign government purchases. The foreign country's saving curve shifts to the left, from S 1For to S 2For. The real world interest rate must rise, so the current account deficit in Week 7 Page 4

5 the foreign country equals the current account surplus in the home country. As shown in the figure, S rises, I falls, CA rises, r w rises. d). An increase in foreign taxes (consider both the case in which Ricardian equivalence holds and the case in which it does not hold). If Ricardian equivalence holds, there is no effect. If Ricardian equivalence does not hold, then the result is the same as in part b, as the foreign country's saving curve shifts to the right. Q3: What is convergence? Explain the difference between unconditional convergence and conditional convergence. What prediction does the neoclassical growth model make about convergence? What does the evidence say? Convergence means that over time the living standards in different countries get closer together. Unconditional convergence means that countries converge regardless of differences in their fundamental factors (population growth rates, depreciation rates, production functions), while conditional convergence means that countries will converge if they have the same fundamental factors (even if they begin with different capital labour ratios). The Solow model is consistent with the idea of conditional convergence, since it predicts that convergence will occur if countries have the same fundamental factors. There is little evidence for unconditional convergence, as the poorest countries are failing to catch up with richer countries, but much better evidence supporting conditional convergence. Week 7 Page 5

6 Q4: What two explanations of productivity growth does endogenous growth theory offer? How does the production function in an endogenous growth model differ from the production function in the neoclassical growth model? The new growth theory suggests that the main sources of productivity growth are accumulation of human capital (the knowledge, skills, and training of individuals) and technological innovation (research and development, as well as learning by doing). In endogenous growth model, it assumes constant marginal product of inputs while in the neoclassical growth model, it assumes diminishing marginal product of inputs. Week 7 Page 6