Intermediate Macroeconomics Heman Das Lohano

Assignment 1: Due on 20 April 2020

Instructions:

 Answer all questions. Show your work while answering the questions.
 Complete the assignment in readable handwriting. Write your name on each page.
 Submit the color scan copies of handwritten answers on LMS.
 There would be two assignments in place of mid-term exam. This is the first one. Thus,
solve this assignment on your own and do not share your work with other students.

Q1: (15 marks)

Consider an economy that produces and consumes only two goods. In the following table are
data for two different years. Assume 2015 as the base year.

Year: 2015 2019

Goods Quantity Price Quantity Price
Burgers 400 $3 600 $4
Pizzas 400 $4 300 $6

(a) Calculate nominal and real GDP for 2015 and 2019. By what percentage did real GDP
increase between 2015 and 2019? What is the annual growth rate of the economy during
this period?
(b) What is the GDP deflator in 2015 and 2019? By what percentage did prices rise between
2015 and 2019? What is the annual inflation rate based on the GDP deflator?
(c) Assume that the typical consumer’s basket of goods is given by the average of the quantities
between 2015 and 2019. What is the consumer price index (CPI) in 2015 and 2019? By
what percentage did prices rise between 2015 and 2019? During this period, what is the
annual inflation rate based on CPI?
(d) Is the inflation rate based on GDP deflator lower than the inflation rate based on CPI?
Briefly explain to justify your answer.

Q2: (20 marks)

Suppose the production function in Pakistan economy is as follows:

𝑌 = 10𝐾 1/3 𝐿2/3

where Y is the real GDP, K is the amount of capital, and L is the amount of labor. Assume that
the country possesses 216 units of capital.

(a) Using the above production function, solve the profit maximization problem of the
representative firm and find the labor demand function for given level of capital.
(b) Suppose the supply of labor is fixed at 125 units. Find the equilibrium in the labor market:
real wages (W/P), nominal wages at P = 1, and equilibrium quantity of labor in the market.
Also, compute real GDP and nominal GDP.
(c) Suppose, output price (inflation index) increases to P = 2. Find the equilibrium in the labor
market: real wages (W/P), nominal wages at P = 2, and equilibrium quantity of labor in the
market. Also, compute real GDP and nominal GDP.
(d) Using the answers to parts (b) and (c), draw the aggregate supply curve of real GDP.
(e) In microeconomics, we expect the supply curve for the firm to slope upward to the right
when drawn against price. The classical aggregate supply curve is based on this
microeconomic theory of the firm but is vertical. Why?

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Q3: (20 marks)
Consider the following classical model for an economy:

Real GDP: Y = K 0.5 L0.5

Capital: K = 900
Labor: L = 100

Consumption: C = 20 + 0.8 (Y – T)
Investment: I = 50 – 5 r
Government spending: G = 40
Taxes: T = 50

where r is the real interest rate in percentage terms.

(a) What is the level of real GDP in the economy? What is the real wage and real rental rate of
capital? How much is paid to workers and how much is paid to the owners of capital? How
much is the share of each in percent, and how does it compare with the output elasticity of
input?
(b) How much are households saving? How much is the government saving?
(c) Find the interest rate that produces equilibrium in the loanable funds market. Draw a
diagram to show the equilibrium.
(d) Assume that a natural disaster destroys part of the capital such that new level of capital is
K=841. Find the new equilibrium real interest rate and show the change on the diagram
drawn for part (c).

Q4: (10 marks)

(a) An economy has a monetary base of Rs.8000. Calculate the money supply in scenarios (i)–
(iv):
(i) All money is held as currency.
(ii) All money is held as demand deposits. Banks hold 100 percent of deposits as
reserves.
(iii) All money is held as demand deposits. Banks hold 10 percent of deposits as
reserves.
(iv) People hold equal amounts of currency and demand deposits. Banks hold 10 percent
of deposits as reserves.
(b) Assume that the money supply is Rs.1000. Assume that the reserve-to-deposit ratio (rr) is
0.1 and the currency-to-deposit ratio (cr) is 0.2. How much does the central bank need to
increase the monetary base to attain a money supply equal to Rs.1050? Explain how the
central bank accomplishes this objective.

Q5:
(a) (5 marks)
In Pakistan, the velocity of money is constant. Real GDP grows by 3 percent per year, the
money stock grows by 12.75 percent per year, and the nominal interest rate is 13.25 percent.
What is the real interest rate?

(b) (5 marks)
An economy has 150 people divided among the following groups: 80 have full-time jobs, 20
have one part-time job, 10 would like to work and are looking for jobs, 15 would like to work
but are so discouraged they have given up looking, 5 are running their own businesses, 5 are
retired, and 15 are small children. Calculate the labor force and the labor-force participation
rate. Calculate the number of unemployed and the unemployment rate.

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(c) (5 marks)
Are the purchases of stocks and bonds from the market included in GDP? Yes or No? Justify
your answer.

(d) (5 marks)
Is the inventory investment always positive, or can it be either positive or negative? Justify
your answer.

(e) (5 marks)
An airline company in Pakistan purchases used airplanes from a foreign country. Is this
transaction included in GDP accounting system (GDP = C + I + G + X – M)? Yes or No?
Explain briefly.

Q6: (10 marks)

Instruction: Write letter A, B, C or D only on the answer book for each MCQ.

(1) If the number of employed workers equals 200 million and the number of unemployed
workers equals 20 million, the unemployment rate equals ______ percent (rounded to the
nearest percent).

(A) 0
(B) 9
(C) 10
(D) 20

(2) Discouraged workers are counted as:

(A) part of the labor force.

(B) out of the labor force.
(C) employed.
(D) unemployed.

(3) If the adult population equals 250 million, of which 145 million are employed and 5 million
are unemployed, the labor force participation rate equals ______ percent.

(A) 50
(B) 58
(C) 60
(D) 67

(4) When some of GDP is not purchased in a given year, it is

(A) exported to other countries.

(B) categorized as unplanned inventories under the investment category.
(C) purchased by the federal government.
(D) categorized as unplanned inventories under the consumption category.

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