EC390: Intermediate Macroeconomics II

Winter 2021
Professor Shiamptanis

Analytical Assignment 2
(100 points: Due March 10)

1. (10 points) Suppose that researchers announce a new vaccine for Covid-19 which is
100% e¤ective. This vaccine will be available in a few years. This can be modelled
0
as z unchanged, z increases. Use the real intertemporal model (which includes the
current labour supply, N S ; and demand curves, N D , and the output supply, Y s ; and
output demand, Y; curves) to show graphically what happens to output, employment,
real wages and the real interest rate. Also, infer what happens to investment and
consumption.

2. (10 points) Suppose that the likelihood of a future military con‡ict increases. This can
0
be modelled as G unchanged, G increases. Use the real intertemporal model to show
graphically what happens to output, employment, real wages and the real interest rate.
Also, infer what happens to investment and consumption.

3. (10 points) Suppose that Suppose that severe snowstorm destroys a signi…cant number
of factories and homes. This can be modeled as a decrease in current capital, K: Use the
real intertemporal model to show graphically what happens to output, employment,
real wages and the real interest rate. Also, infer what happens to investment and
consumption.

4. (20 points) Consider the following investment decision. The …rm’s future output is
given by
0:4 0:6
Y 0 = z 0 (K 0 ) (N 0 ) ;
where: Y 0 is future output; K 0 is future capital; N 0 = 1977:9 is future labor, measured
in hours per year; and z 0 = 0:08 is future total factor productivity. Capital evolves
according to
0
K = (1 d) K + I;
where: K = 296 is current capital; d = 0:07 is the depreciation rate and I denotes
investment. The …rm chooses future capital to maximize

V = z (K)0:4 (N )0:6 wN [K 0 (1 d)K]

1 h 0 0 0:4 0 0:6 i
+ z (K ) (N ) w0 N 0 + (1 d)K 0 :
1+r
where r = 0:03 is the real interest rate.

(a) (4 points) Compute the optimal value of K 0 . After you compute the desired future
capital, compute the desired investment.

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 (b) (4 points) Suppose z (K)0:4 (N )0:6 wN 1+r 1
w0 N 0 = 0: Show that the value of
K 0 computed in part (a) is indeed the optimal value of K 0 by completing the
following table:

Y0 = I=
z 0 (K 0 )0:4 (N 0 )0:6
0 0 0
K (1 d) K K (1 d) K V
291:000
value from part (a)
300:000

(c) (2 points) Suppose that current capital, K, increases from 296 to 308. What is
desired investment now?
(d) (4 points) Suppose that z 0 increases to 0:082, while K is back at its original value
of 296. Compute the new optimal value of K 0 and the new desired investment.
(e) (2 points) Suppose that z 0 increases to 0:082, while K, increases from 296 to 308.
What is desired investment now?
(f) (4 points) On a single graph, show how the changes you considered in parts (c),
(d) and (e) shift the desired investment schedule. Your graph should clearly label
the four curves: one for part (a), one for part (c), one for part (d), and one for
part (e), and include the values of desired investment under each case.

5. (20 points) Let’s compare the Canadian economy in 2010 to the current economy.
The two major changes between 2010 and 2020 are: (1) total factor productivity has
permanently increased (z and z 0 both increase); and (2) the capital stock, K, has
increased.

(a) (15 points) Using the real intertemporal model we developed in class, show graph-
ically how these changes have a¤ected output, employment, real wages and the
real interest rate. What happens to consumption? Based on your answer to
question 4(e), what happens to investment?
(b) (5 points) Show that it is possible that the real interest rate remains unchanged.
Look brie‡y at …gure 1.10 (page 19) in the Williamson book between 2010 and
2020. According to this chart, is it realistic for real interest rates in a growing
economy to show no long-term trend?

6. (10 points) Suppose that the price of oil temporarily increases.

(a) (1 point) Will this cause current total factor productivity, z, to increase or de-
crease?
(b) (9 points) Using the real intertemporal model we developed in class, show graph-
ically how the oil price change would a¤ect output, employment, real wages and
the real interest rate. What happens to consumption and investment?

7. (5 points) Suppose that the government reduces current lump-sum taxes, but does not
change current or future government purchases. Using the real intertemporal model

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 we developed in class, show how these changes would a¤ect output, employment, real
wages and the real interest rate. What happens to consumption and investment?
(Hint: Graphs are unnecessary if you can provide a brief but compelling economic
argument.)

8. (15 points) In questions 1(c) of Exam 1, you investigated the e¤ects of imposing a
proportional labour income tax, rather than lump-sum taxes. Suppose that this new
…scal regime is permanent, i.e., the government makes purchases and collects labour
income taxes in all periods. Using the real intertemporal model we developed in class,
show graphically how these changes would a¤ect output, employment, real wages, and
the real interest rate. (Hint: You should review question 1(c) of Exam 1 to determine
how the labour market changes, and you should then determine how desired output
demand changes.)