QUIZ 1: Macro Winter 2007

Name:

______________________ ! ":#0$11:#0 Q&estion 1 S %:00$12:00

Section Registered (circle one

'&t ans(ers in t)e s*ace *ro+ided, Calculators are allowed. Answers will be graded on a
partial credit scale. Perfect answers with the appropriate documentation of your work will be given the complete score; answers with an intuitive attempt at the correct procedure but a wrong answer will be given 50% credit; answers with a totally incorrect procedure even if the answer is correct! will be given either 0 or " point. -)is im*lies t)at .o& m&st s)o( .o&r (or/ to get 0&ll credit1111

#uppose you were given the following data about average hourly wages of all $.#. employees for the following years. All wages are reported in current year dollars i.e.% "&'' wages are in "&'' dollars% etc.!. ( also listed the corresponding CP( for those years. )hese data are actual $.#. wage and CP( data. ( picked data from *anuary of each year so the CP( and wage data will correspond to the same time period. )he current base year of the CP( is "&+, CP( in "&+, - "00!. "&'' "&&, ,005 ,00' .ages /5.,0 /"0.0' /"5.&" /"'."0 CP( 5+.' "1+.0 "&".1 ,01.,

)he 2uestion we are going to address is the e3tent to which real wages in the $.#. have changed over the last 10 years and the e3tent to which the accuracy of the CP( affects the conclusions about changing well being over time as measured by changes in the average wage within a society!. a! (n ,005 dollars% what was the real wage in the $. #. in "&&,4 convert all nominal wages into real wages. 5 points! $se the CP( to

)his 2uestion was nearly identical to the e3ample ( went through in the supplemental notes. (n that e3ample% had you compute real wealth in different years in "&&0 dollars!. (n this 2ui6% you need to compute real wages from different years in ,005 dollars!. )he mechanics of the problem are e3actly the same. )his 2ui6 2uestion% given the supplemental notes% was even easier than the 2uestion from last years 2ui6. Real wage in 1992 = [Nominal Wage in 1992/CPI(1992)] * CPI(2005) = [10.67/1 !] * 191. = "1#.79 (in 2005 $olla%&)

b!

(n ,005 dollars% what was the total growth rate in real wages between "&'' and ,00' use the e3act formula!4 5 points!

7or this 2uestion% you follow the same procedure as above. 7irst% convert the "&'' and ,00' wages into ,005 dollars. i! Real wage in 1977 = [Nominal Wage in 1977/CPI(1977)] * CPI(2005) = [5.26/5!.7] * 191. = "17.1# (in 2005 $olla%&) = [Nominal Wage in 2007/CPI(2007)] * CPI(2005) = [17.10/20 .2] * 191. = "16.10 (in 2005 $olla%&)

ii!

Real wage in 2007

#econd% compute the growth rate in real wages. 8rowth rate in real wages 9'':0'; - 9<eal wage ,00'!=<eal wage "&''!; > " - 9"0."0="'."5; > " - :0."%

( asked for the total change over the thirty years. ?ut% some people gave the annual change over the 10 years of about :0.,% per year. )hat is fine as well. c! )here is an abundance of evidence suggesting that the CP( inflation rate is biased upwards. A consensus is emerging that the bias is around "% per year. )he reason is that the CP( does not accurately measure 2uality improvements in goods attributing the change in price for a good solely to changes in inflation% on average% not to the fact that the average good is improving in 2uality over time!. (f the CP( inflation rate is actually biased upwards by " percent per year% what would be the total real wage growth between "&'' and ,00' if one ad@usted for such a bias4 Aou can use the appro3imation formula if you want > @ust make sure you ad@ust the appro3imation for compounding that occurs from a "% bias over 10 years. 1 points! )his was the easiest part of the 2ui6. (f the inflation rate was overstated by "% per year% then over 10 years% the inflation rate would be 15.'+ percent lower ".0"!10:". (f the bias is true% the growth in wages would be roughly 15.'+% higher than the answer in part b. As a result% the actual change in real wages would be about ,+.+%. #ome people used an e3act formula which yielded an answer of ,0.5%.

Q&estion 2 Bast week in class% ( told you that the main reason that economists care about high inflation is that it creates uncertainty in the economy. .hy does a high inflation rate create uncertainty in the economy4 7ocus your answer on the lending market. .hy canCt lenders and borrowers price this inflation uncertainty4 Aour answer should not be more than three well constructed sentences. Also% this 2uestion has nothing to do with inde3ing > so inde3ation should not be part of your answer. 5 points! Digh inflation rates are almost always associated with variable inflation rates. As the inflation rate variance increases% the uncertainty over real returns increases. (f borrowers and lenders are risk averse% both need to be compensated for the increased risk. Benders get compensated by charging an increased rate and borrowers get compensated by paying a lower rate. )he result is less economic transactions between borrowers and lenders occur. Q&estion # (n EFivining the 7utureG '(onomi&) "="5=,005!% the article said the HC<( Hconomic Cycle <esearch (nstitute! made a prediction about the $.#. economy in Iarch of ,00". .hat was that prediction4 Aour answer should be no more than ' words. 5 points! )he $.#. economy is entering a recession.