Homework 2-
1. Your liberal-activist roommate is plotting to bring down capitalist society. He/she claims that workers are being cheated out of compensation that is rightly theirs. He/she points to sizable profit announcements by large corporations as evidence that workers should be paid more. You decide (unwisely) to debate the issue from the standpoint of an academic economist.
a. What common misconception about profit should you point out in your opening statement?
b. Explain how economists believe that wages are determined.
c. Show how if the aggregate production function is homogeneous of degree one (which is a reasonable long run assumption) that economic profit is zero rendering your roommate's argument based upon profit weak. Be thorough in your explanation since your roommate is not easily convinced.
2. Suppose that the economy's output is fixed by the amount of labor and capital present, the government balances its budget, the m.p.c. is 0.9 and NX=0. Suppose the government increases its spending by 20% (taxes must increase to keep the budget balanced).
a. Write the change in investment as a function of the initial level of government spending.
b. What must happen to the interest rate?
c. In general, find an expression for the change in investment as a function of the change in government spending.
d. Suppose now that when the government increases (or decreases) spending it leaves taxes unchanged. Find an expression for the change in investment as a function of the change in government spending.
e. Regardless of how the government finances increased spending what is the effect on savings and the interest rate? Briefly explain.
3. For the years 1999 through 2004 collect data to calculate an estimate for the velocity of money. Nominal GDP can be used as an estimate of
Price x Output.
Data on the money stock can be found on the St. Louis Federal Reserve's website located at http://research.stlouisfed.org/fred2/categories/24. Calculate the velocity using M1, M2, and M3 for each year. You will need to average the quarterly reports to get a yearly average of the money supply.
a. Over the 5 years examined what is the trend in velocity?
b. Which money aggregate is most consistent with a constant velocity?
c. Having examined the data, is the assumption of a constant velocity justified?
4. Again, record the price of the basket of goods you selected in the previous homework. Calculate a CPI like figure for the first period and this second period with the first measurement period being the base period.