ECON2420 The Macroeconomy & Business Conditions
The Macroeconomy & Business Conditions
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ECON2420 The Macroeconomy & Business Conditions
Instructions: There are 7 problem-solving and short-answer questions. Answer all questions.
Justify all your answers. Every graph (figure or diagram) –including all curves and axes– should
be well-labelled. You are not allowed to insert graphs copied directly from the textbook, lecture
materials or tutorial materials. Show your work. Marks are as indicated (total marks: 100).
Question 1 (20 marks) Consider the Economic Growth Model in which the production function
is constant returns to scale and it requires only two inputs, capital (K) and workers (N). Assume
the production function is
f(K,N) = Y = K0.3N0.7,
where Y = output units, K = capital units, and N = amount of workers. The saving rate in this
economy is 12% and the depreciation rate is 6%. The number of workers remains constant.
(a) (2 marks) Write down the steady-state condition for this production function.
(b) (5 marks) Find the value of the steady-state capital per worker. Show all the steps of your
derivation.
(c) (5 marks) Find the value of the steady-stead output per worker. Show all the steps of your
derivation.
(d) (8 marks) Given the depreciation rate of 6%, find the stead-state golden-rule saving rate.
Show all the steps of your derivation.
Question 2 (25 marks)
Consider the Economic Growth Model with constant returns to scale (for K and N). The production
function is
f(K,N) = Y = K0.4(AN)0.6,
Where Y = output units, K = capital units, and AN = effective workers. The saving rate in this
economy is 20%, the depreciation rate is 10%, workers grow at rate 3%, and technology grows at
rate 4%.
(a) (3 marks) Write down the steady-state condition for this production function.
(b) (5 marks) Find the value of the steady-state capital per effective worker. Show all the steps
of your derivation.
(c) (5 marks) Find the value of the steady-state output per effective worker. Show all the steps
of your derivation.
(d) (2 marks) Find the stead-state growth rate of output per worker. Show all the steps of your
derivation.
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Semester Two Final Examinations, 2022 ECON2420 The Macroeconomy & Business Conditions
(e) (2 marks) Find the stead-state growth rate of capital. Show all the steps of your derivation.
(f) (8 marks) The standard of living is measured by the level of output per worker, Y/N . Explain
and illustrate graphically how a higher growth rate of technology improves the standard of
living whereas a lower saving rate deteriorates it.
Question 3 (15 marks) Answer the following questions:
(a) (5 marks) Given a fixed amount of workers (N), explain how a higher labour productivity
increases the output level. Also explain how, conversely, a higher output level increases
labour productivity. (Hint: “causality effect.”)
(b) (10 marks) Empirical evidence suggests that, in the medium run, there is an inverse relation
between productivity growth and the unemployment rate. Apply (and illustrate graphically)
the theory from chapter 13 in the textbook to explain this phenomenon. (Hint: use the
wage setting and price-setting relations.)
Question 4 (10 marks) Explain how the present value of a sequence of payments is affected by
each of the followings (ceteris paribus):
(a) (2.5 marks) An increase in a future expected payment.
(b) (2.5 marks) A decrease in the current payment.
(c) (2.5 marks) An increase in the expected future nominal interest rate.
(d) (2.5 marks) An increase in the current nominal interest rate.
Question 5 (10 marks) Consider the government spending G and taxes T as given. Assume
no output growth, that is gY = 0. The central bank uses a contractionary monetary policy by
decreasing the inflation target from 5% to 4%. Ceteris paribus, what would happen to the following
in the medium-run?
(a) (2.5 marks) The natural level of output, Yn.
(b) (2.5 marks) Money growth, gM .
(c) (2.5 marks) Real interest rate. (Hint: The natural real interest rate, rn, is the real interest
rate needed to sustain G when the output is at its natural level, Yn.)
(d) (2.5 marks) Nominal interest rate.
Question 6 (10 marks) Assume that P/P ∗ remains constant, where P is the domestic GDP
deflator and P ∗ is the foreign GDP deflator. Suppose that the nominal domestic currency depreciates.
(a) (4 marks) How does this nominal depreciation affect the relative price of domestic goods
(that is, the real exchange rate)? Explain.
(b) (4 marks) Based on your answer in part (a), how does this nominal depreciation affect the
(world) demand for domestic goods? Explain.
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Semester Two Final Examinations, 2022 ECON2420 The Macroeconomy & Business Conditions
(c) (2 marks) Based on your answer in part (b), how does this nominal depreciation affect the
the domestic unemployment rate in the short run? Explain.
Question 7 (10 marks) Suppose that a country’s output is below the policy-makers’ desired
level of output and is experiencing a trade surplus. Assume that the policy makers’ goals are to
achieve the desired level of output (i.e., the natural level of output) and balanced trade. Given this
information, what type of exchange rate and/or fiscal policy can be used to achieve simultaneously
these two goals? Explain.
Question 8 (no marks) Specify any assumptions you have made in completing the exam and to
which questions those assumptions relate. You may also include queries you may have made with
respect to a particular question, should you have been able to ’raise your hand’ in an examination
room.