Fall 2000

ECONOMICS 1312

J.G. Gonzalez

 

 

 

 

Problem Set # 2

 

 

            This problem set is due Thursday, October 26, at the beginning of the class period.  Problem sets done on notebook paper or unstapled will not be accepted.  Late problem sets are unacceptable also.

 

1.  In 2000 Japan faces a large international trade surplus (or positive net exports).

a)  Draw a diagram representing the Japanese economy during 2000 (Hint:  In this diagram, equilibrium output must occur at a level in which net exports are positive; and this should be shown in your diagram).

 

b)  Assume that the government wants to reduce the trade surplus without changing the level of national output.  Describe the changes in fiscal policy and in the exchange rate that would be necessary to achieve these objectives.  Use a diagram to show the effects of your proposed policy changes.

 

2.  You are given the following information about Pichu’s economy: 

 

a)  How much would Pichu’s equilibrium level of output be?

 

b)  How much would net exports be when this economy is at equilibrium output?

 

c)  Pichu’s main exports are llamas.  Due to a genetic experiment conducted by Dr. Yzma (a famous Pichu scientist), there is a dramatic decline in the llama population in Pichu.  Consequently, Pichu’s exports decline by $300 million to a new level of $500 million.  How much would Pichu’s new equilibrium level of output be?

 

d)  How much would net exports be when this economy is at its new equilibrium output?

 

e)  Emperor Kuzco, Pichu’s leader, decides that he wants equilibrium output to go back to its original level.  How much would he have to decrease taxes to achieve his objective?

 

f)  How much would net exports be when the policies of Emperor Kuzco bring equilibrium output back to its original level?

 

3.  You are given the following information about the U.S. economy:  When unemployment is at its natural rate, which is 5 percent, government spending is 15 percent of GDP, while taxes and other government revenues are equal to 12 percent of GDP. For each 1 percentage point increase in the unemployment rate, government spending increases by 2 percentage points of GDP and taxes fall by 3 percentage points of GDP.  There is no inflation.

 

a)  In 2001, the unemployment rate is 4%.  Calculate the actual, structural, and cyclical deficits (as percentages of GDP) of the U.S. government.

 

b)  In 2002, the unemployment rate is 6%.  Calculate the actual, structural, and cyclical deficits (as percentages of GDP) of the U.S. government.

 

c)  In 2003, the unemployment rate is 8%.  Calculate the actual, structural, and cyclical deficits (as percentages of GDP) of the U.S. government.

 

d)  In 2004, the U.S. Congress and President Gosh decide to cut taxes and increase government expenditures to stimulate the economy.  Now you are told that when unemployment is 5 percent, government spending is 18 percent of GDP, while taxes and other government revenues are equal to 10 percent of GDP.  Furthermore, as happened before, for each 1 percentage point increase in the unemployment rate, government spending increases by 2 percentage points of GDP and taxes fall by 3 percentage points of GDP. Assuming that these policies make the unemployment rate fall to 6%, calculate the actual, structural, and cyclical deficits (as percentages of GDP) of the U.S. government.

 

e)  In 2005, the unemployment rate is 5%.  Calculate the actual, structural, and cyclical deficits (as percentages of GDP) of the U.S. government (Assume that the changes that took place in 2004 are permanent).

 

4.  You are given the following information about Mana’s economy:

·        Each year consumers spend $500 million regardless of the level of their disposable income.  In addition to that $500 million, they always spend 80% of their yearly disposable income.

·        Investment is fixed at $1,000 million.

·        Government expenditures are $800 million.

·        Taxes equal 25% of income.

·        Exports are $2,000 million.

·        Imports are always equal to $1,500 million plus 30% of the level of disposable income.

 

a)  How much would Mana’s equilibrium level of output be?

 

b)  How much would net exports be when this economy is at equilibrium output?

 

c)  How much would the net government surplus (or deficit) be when this economy is at equilibrium output?

 

d)  Due to lack of confidence in the economy, Mana’s investors decide to cut their investment level by $900 million to a new level of only $100 million.  How much would Mana’s new equilibrium level of output be?

 

e)  How much would the net government surplus (or deficit) be when this economy is at its new equilibrium output?  Was this change in the surplus (or deficit) due to structural or cyclical reasons?  Explain.

 

f)  Following supply-side ideas, and in order to stimulate the economy Mana’s President, Dr. Fher Olvera, cuts taxes from 25% of income to a new level of only 21% of income.  How much would Mana’s new equilibrium level of output be?

 

5. Visit the U.S. Office of Management and Budget web site (http://www.gpo.gov/usbudget/index.html) and use the FY 2001 Federal Budget Publications to obtain the data necessary to answer the following questions.

 

a)  How much was the total budget surplus or deficit of the Federal Government for each year from 1980 until 1999? (Note:  You should look for the Historical Tables section, Table 1.1-Summary of Receipts, Outlays, and Surpluses or Deficits:  1789-2005 to get these numbers)

 

b)  Was the change in the actual deficit from 1980 to 1983 mainly due to cyclical or structural reasons?  Explain.

 

c)  Was the change in the actual deficit from 1984 to 1986 mainly due to cyclical or structural reasons?  Explain.

 

d)  Was the change in the actual deficit from 1990 to 1992 mainly due to cyclical or structural reasons?  Explain.

 

e)  Was the change in the actual deficit (or surplus) from 1992 to 1999 mainly due to cyclical or structural reasons?  Explain.

 

f)  How much was the estimated yearly total budget surplus or deficit of the Federal Government from 2000 until 2005 according to the Historical Tables (these estimations were prepared at the beginning of 2000)?

 

g)  How much was the estimated yearly total budget surplus or deficit of the Federal Government from 2000 until 2005 according to the Mid-Session Review Table (You need to look for Table 1. Budget Policy Totals in the Executive Summary of this review that was prepared during the summer of 2000)?

 

h)  Why are the two estimates from parts f) and g) different?  Are these changes due to cyclical or structural reasons?

 

6.  Assume that you are hired as an economic advisor to the Chairperson of the Federal Reserve Bank.  Your boss is interested in knowing the different levels of investment that would take place when the interest rate changes.  She gives you the following information about the projects that investors are contemplating for this year (Note:  Operation costs do not include financial costs):

 

 

Project

Total

Investment

 

Revenues

Operation

      Costs

A

600

100

70

B

250

100

75

C

200

30

25

D

900

700

600

E

350

225

200

 

a)  How much would the level of investment be when the interest rate equals 8%?  Explain fully.

 

b)  How much would the level of investment be when the interest rate equals 4%?  Explain fully.

 

c)  Use the information from parts a) and b) to draw the investment demand curve for this economy.

 

d)  The Chairperson of the Federal Reserve System is contemplating an contractionary monetary policy that would result in an increase in the interest rates from 4% to 8%.  Assuming that you are a mainstream economist, what would you predict the result of this policy would be on the level of real GDP and on the price level?  Draw a diagram in support of your answer and explain fully  (Note:  You do not have sufficient data to provide exact numbers for real GDP nor price level, however, you can discuss the direction of their changes).

 

 

7.  Visit the Bureau of Economic Analysis web site (http://www.bea.doc.gov/).  Click on “GDP and related data.”  Then click on “GDP and other major NIPA series” and click on “Table 1” (in either format).

 

a)  Write down the Gross Domestic Product, Personal Consumption Expenditures, and Imports for every year from 1991 until 1999 (use yearly data).  Use these data to calculate the implied values for the marginal propensity to consume and the marginal propensity to import, assuming that taxes do not vary with income.

 

b)  Calculate the open economy multiplier for every year from 1991 until 1999 (assume that taxes do not vary with income).

 

c)  What happened to the open economy multiplier from 1997 to 1999?  Why did it increased (or decreased)?  What does this imply for the effect of a change in government expenditures on GDP?