UN 1105: Principles of Economics

Problem Set #4 – November 28

Fall 2023
Waseem Noor (section 2)

Problem Set Guidelines

● You will receive 4 assigned problem sets through the semester and together they account for 25% of
your grade. This problem set is due at 11:30pm on Monday, December 11.

● A scanned PDF copy of the problem set should be uploaded into Gradescope by 11:30pm on Monday,
December 11. The system will count your homework as late if submitted after that time. Late problem
sets will automatically be deducted by 25% for each 24-hour period they are late. There will be no
exceptions. Problem set solutions will be discussed during the recitation session.

● Students can work on problem sets in groups of a maximum of three people. If submitting individually,
each student should 1) write up his/her/their own solutions, 2) list all the names of the people in their
group, and 3) submit their own work.

● Please write answers for each of the ten problems on a different side of paper and assign each page to
their respective question as indicated on Gradescope. To do so, students must select the question on the
left bar and match the pages of their PDF containing those answers on the right. Failure to assign pages
will result in point deductions. For help, please visit:
https://help.gradescope.com/article/ccbpppziu9-student-submit-work

● TAs will read and grade all the problem sets, so please write legibly and show your work. All graphs
should have units and axes clearly labeled. If the TAs cannot read the answers they will not be able to
give you credit.

● It goes without saying that copying your solutions from others is considered cheating and will be
sanctioned. (please read Columbia’s policy on academic integrity at
https://www.college.columbia.edu/academics/academicintegrity).

● You may submit this assignment as a group. To do that:

• One member of the group should upload the assignment.
• Once the file is submitted, there should be an option in the upper right-hand corner to add group
members. Please click that option and select your group members from the class.
• Your partners should receive an email that an assignment has been submitted on their behalf.

● You may use Excel for the calculations in this problem set. If you do so, please write out the answers on
paper and copy the Excel spreadsheet alongside the scanned homework.

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Problem Set #4 – UN 1105 – Noor – Fall 2023
 1) Drivers for Uber and Lyft are considered part of the gig economy and are not employees of their
companies. Several efforts are underway to reclassify these drivers as employees so that they can
form unions and negotiate higher wages.

a) Assuming that the labor market is frictionless (so that drivers can easily enter and exit) and all
other assumptions of perfect competition apply, where would the labor market clear in the graph
above?
b) In the real world, which assumptions of perfect competition do you think would not apply in this
type of market, and why?
c) Assume that the union efforts are successful, and a minimum wage is implemented. How is the
equilibrium in the market likely going to change? How will this be reflected in the graph above?
d) How will unemployment change if the efforts are successful? Explain any social gain or loss
from this change?
e) Why might the ride-sharing services want to pay higher wages even if the negotiations are not
successful?
f) You find out that the market is not frictionless, and there was unemployment in the riding
sharing labor market before the wage increase was negotiated. How is this situation reflected in
the graph above? What might be the reasons? Explain your reason.

2) Explain how the credit markets, specifically the equilibrium real interest rate and the equilibrium
quantity of credit, would change in each of the following scenarios, and illustrate your answer with
a well-labeled graph of the credit market. Assume that the agents described are large enough to
impact the aggregate macro market. There can be more than one correct answer, and you only need
to provide one for each scenario.

a) An electric car manufacturer decides to expand its factories because of greater internal
demand.
b) American Airlines makes large profits from summer travel and decides to save some of its
profits for purchasing new planes in a year.
c) Tech companies are not performing well and layoff about 20,000 employees.

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Problem Set #4 – UN 1105 – Noor – Fall 2023
 3) The following table shows the balance sheet for Greedior Bank. The bank has a required reserve
ratio of 5 percent and has $75 in excess reserves.

a) What are the values of the cells that are blank?

b) If the bank decides to decrease excess reserves by $25, how does Total Liabilities change?
How does Stockholders’ Equity change? How does Total Liabilities + Stockholders’ Equity
change? Explain the intuition of each of the changes.
c) What happens to Long-term investments if Cash Equivalents increases by $300. Explain the
intuition of the change.

4) Phoenix, AZ is limiting construction of housing since there will not be enough groundwater for
additional projects due to climate change. If companies continue to add offices in the area, that
means the value of the existing supply of houses will go up. Moishe and Mannan are buying a house
in Phoenix. They have a joint account with $275,000 in savings, and the place they are interested in
a house that costs $560,000. They go to Greedior Bank where they have all their savings, and it is
the same bank at which all their other friends have accounts. At Greedior Bank, Moishe learns that
he can borrow at a nominal interest rate of 9.5% percent. The prediction is that inflation will be 4
percent for 3 years after he buys the house and then will decrease to 3 percent in four years.

a) If they don’t take a loan, are Moishe and Mannan debtors or lenders in relation to Greedior
Bank? If they take a loan from the Bank to cover the difference between the cost of the new
house and their savings, are they debtors or lenders? Explain.
b) Assume Moishe and Mannan take the loan at 9.5 percent on January 1 and make annual
beginning-of- year payments of $110,000, how much will they owe at the beginning of year
3? This question deals with a process known as amortization. At the end of the year, the total
amount owed for that year is the amount owed from this year + interest on amount owed from
this year. Households make their payments on Jan 1 the following year.
c) What if the inflation rate for the next 3 years was 6% instead of 4% and the nominal interest
rate stayed the same. Would this benefit Moishe and Mannan? Why or why not?
d) Just before Moishe and Mannan purchase the house, the city of Phoenix starts to tax the
purchase of apartment buildings, and so the price of real estate increases by 5 percent. How
might this affect their inclination in buying the house? How will it affect their payments? No
rigorous mathematical analysis is required. Just explain your reasoning in complete sentences.

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Problem Set #4 – UN 1105 – Noor – Fall 2023
 5) Neophyte Bank is starting out with excess reserves of $2800 and then has the following transactions:
▪ Piotr deposits $16,000.
▪ Fernanda deposits $9,000.
▪ Avery takes out a loan for $8,000.
▪ Neophyte Bank loans $6,000 to Greedior Bank.
▪ Neophyte Bank invests $1,800 into its building and office.
▪ Stephan takes out a business loan for $7,750.
▪ Neoophyte Bank loans $2,000 to a digital currency company.

a) What are Neophyte Bank’s total reserves? Assume that the Federal Reserve requires a reserve
ratio of 5 percent.
b) What are its total assets and total liabilities? What is its stockholders’ equity?
c) Say the following things now happen:
▪ Neophyte Bank loses 75 percent of its investment with the digital currency company
▪ Avery pays back her loan plus 10 percent interest.
▪ Greedior pays back its loan
▪ Stephan defaults on his loan and can’t pay any of it back.
What is the current value of Neophyte Bank's stockholders' equity?
d) Are you worried there may be a run on the bank? Explain.

6) After every meeting, the FOMC releases a statement that summarizes their policy decisions. For this
problem, look up the press release “Federal Reserve issues FOMC statement” from March 22, 2023
which is available at their website (https://www.federalreserve.gov/newsevents/pressreleases.htm).

a) What actions are the FOMC committing to? What is the economic situation that the committee is
facing while making their decision?
b) What open market operations is the FOMC planning to use? Draw the Federal Funds Rate graph
to show what the FOMC hopes to achieve using these measures.
c) Now find the March 23, 2020 statement of the FOMC. What was the economic situation that the
committee faced while making their decision at that time? What actions that we learned in class
does the Fed say it will undertake given the current situation?
d) How is the March 2023 policy direction different from or similar to the direction taken in March
2020. How would you expect the recent policy direction to affect the long-term real interest rate,
employment, and the money supply?

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Problem Set #4 – UN 1105 – Noor – Fall 2023
 7) The world was experiencing inflation in the past year. Describe who will benefit or lose from inflation
in the following cases, ceteris paribus.

a) Before going to college two years ago, Thor borrowed $20,000 from his parents. Thor agreed that
he would pay his parents $20,000 once he graduated four years later. During the past two years in
college, inflation was higher than expected. Thinking only about the loan, who will benefit or
lose out from inflation? Why?
b) When Fumiko retired from working at Toyota last year as an engineer, she received a pension.
The pension is that Toyota pays her 1.6 million Japanese yen the first year, with the amount
increasing by 2 percent each year thereafter. If inflation turned out to be 3 percent in Japan last
year, who will benefit or lose out from inflation? Why?
c) Shanteesha works at a company that increases her salary every year to accommodate increases in
consumer prices. If the inflation rate is lower than expected, who will benefit from inflation?
Why?

8) The following table shows the initial balance sheets of BankAvarice and The Federal Reserve (The
Fed). Suppose that The Fed then buys $40 million in bonds from BankAvarice.

a) What are total assets and total liabilities for BankAvarice after the transaction? Write down the
new balance sheet for BankAvarice.
b) Excess reserves are reserves that banks hold beyond what they are required to hold to meet
their reserve requirement. Assume that the reserve ratio is 5%. What are excess reserves for
BankAvarice before and after the transaction? What are the pros and cons for BankAvarice of
holding excess reserves?
c) What are total assets and total liabilities for the Fed after the transaction? Assume the
proceeds are held by BankAvarice in Fed reserves (as opposed to, for example, cash) to take
advantage of the essentially risk-free federal funds rate. Write down the new balance sheet for
the Fed.
d) Why would the Fed conduct such a transaction?

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Problem Set #4 – UN 1105 – Noor – Fall 2023
 9) Two neighboring countries – Capitalista and Communista – are experiencing high inflation and
they have different monetary and fiscal policy responses.
a) Capitalista’s government is decreasing government spending, while Communistas’ Central
Bank is decreasing the federal funds rate. Explain how the two policies will impact inflation.
b) How will Fiscal countercyclical policy affect the labor market in Capitalista if wages are
downwardly rigid? Explain with a diagram.
c) Of these groups in Capitalista which would be happy or sad with the government policy: 1)
workers who are employed on short-term contracts, 2) workers whose salary increases are tied
to consumer prices, 3) banks owners in Capitalista. Why?
d) The unemployment rate in Communista has been decreasing. What will be the impact on the
labor market and inflation if the government increases government spending there as well?
e) Of these groups in Communista which would be happy or sad with the government policy: 1)
ex-government employees who are retired and receive a pension, 2) students who have taken
out loans for college from the government, 3) banks owners in Communista. Why?

10) The Food and Drug Administration (FDA) is responsible for protecting the public health by
assuring the safety, efficacy, and security of human and veterinary drugs, biological products,
medical devices, our nation's food supply, cosmetics, and products that emit radiation. Based in the
United States, the FDA conducts domestic activities like ensuring the safety of the food chain, and
addressing the opioid crisis. The agency also provides a ‘public good’ service role to other
countries by determining the efficacy and safety of pharmaceutical products. The public good
service is comparable to a Fire Department or Police Force for a city. The FDA is paid for by US
taxes and private donations. The requested budget from the Congress for FY 2024 is $7.2 billion.

a) Look through the FDA budget request to Congress for FY 2024

(https://www.fda.gov/about-fda/reports/budgets) specifically the three documents under
‘2024 Budget’. How much additional money is the FDA requesting in 2024 over 2023?
What are some of the major programs on which the money will be spent?
b) If the US government expenditure on the FDA goes up as requested what could be the
economic impact on US GDP in the short run?
c) What economic impact would an increase in government expenditure have on the GDP of other
countries?
d) If the US government doesn’t grant the additional money requested by the FDA and instead
spends the money subsidizing the domestic car industry, what will be the short-term impact
on US GDP? What could be the longer-term impact on health, human capital and US GDP?

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Problem Set #4 – UN 1105 – Noor – Fall 2023
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Problem Set #4 – UN 1105 – Noor – Fall 2023