ECON2020 Semester 1, 2025
Problem Set
Assessment weight: 30%
Due date: Friday 4 April, 4pm
Word length: The suggested word length is roughly the equivalent of 2000 words or 5 x A4 pages in 11 or
12 point font with standard margins. This is neither a minimum nor a maximum length but rather a
suggested length. Some students who write concisely may be able to produce high quality answers with
fewer words/pages. You will not be rewarded for writing more than necessary to answer the question. If
you use a diagram, it should occupy approximately one third of an A4 page.
Your answers should be typed, but diagrams may be either created with software (e.g. Word, PPT or other)
or neatly hand-written. Diagrams must not be cut and pasted from any source.
You must explain all of your answers and show all working for questions that require calculations and/or
algebra.
See further instructions for submission in the assessment folder.
Unless an extension has been granted, a penalty of 3 marks (out of 30) will be deducted per day for up to 7
calendar days, at which point any submission will not receive any marks.
Answer all of the seven (7) questions.
Marking criteria: For all questions, marks will be awarded according to:
• Clarity and accuracy of calculations;
• Clarity and accuracy of data presentation;
• Clarity and coherence of explanations;
• Accurate and appropriate application of appropriate economic models, including diagrammatic
analysis where required;
• Quality of writing and overall presentation.
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Question 1
Suppose that an economy’s production function is Cobb–Douglas with parameter =0.3. Assume that firms
are highly competitive and maximise profits.
(i) What fractions of income do capital and labour receive?
Suppose that immigration increases the labour force by 10 percent. What happens to:
(ii) Total output (in percent)?
(iii) The rental price of capital?
(iv) The real wage?
Suppose that the productivity of the available technology across increases by 10%. What happens to:
(v) Total output (in percent)?
(vi) The price of capital relative to labour?
(vii) Explain the intuition for your answer to part (v)
Explain your answers and show all working.
[7 marks. 1 mark for each part]
Question 2
According to the neoclassical theory of distribution, a worker’s real wage reflects her productivity. Let’s use
this insight to examine the incomes of two groups of workers: farmers and barbers. Let Wf and Wb be the
nominal wages of farmers and barbers, Pf and Pb be the prices of food and haircuts, and Af and Ab be the
marginal productivity of farmers and barbers.
(i) For each of the six variables defined above, state as precisely as you can the units in which they are
measured. (Hint: Each answer takes the form “X per unit of Y.”)
Over the past century, the productivity of farmers, Af, has risen substantially due to technological progress.
(ii) According to the neoclassical theory, what should have happened to farmers’ real wage, ⁄ ? In
what units is this real wage measured?
Over the same period, the productivity of barbers, Ab, has remained constant.
(iii) What should have happened to barbers’ real wage, ⁄ ? In what units is this real wage
measured?
Suppose that, in the long run, workers can move freely between being farmers and being barbers.
(iv) What does this mobility imply for the nominal wages of farmers and barbers, Wf and Wb ?

(v) What do your previous answers imply for the price of haircuts relative to the price of food, ⁄ ?
Suppose that barbers and farmers consume the same basket of goods and services.
(vi) Who benefits more from technological progress in farming: farmers or barbers? Explain how your
answer is consistent with the results on real wages in parts (b) and (c).
Explain your answers and show all working.
[6 marks. 1 mark for each part]
Question 3
Suppose that the money demand function takes the form ( ⁄ ) = (, ) = (5)⁄ , where M is the
volume of money, P is the price level, Y is output and i is the nominal interest rate.
(i) If output grows at rate g and the nominal interest rate is constant, at what rate will the demand for
real balances grow?
(ii) What is the velocity of money in this economy?
(iii) If inflation and nominal interest rates are constant, at what rate, if any, will velocity grow?
(iv) How will a permanent (once-and-for-all) increase in the level of interest rates affect the level of
velocity? How will it affect the subsequent growth rate of velocity?
(v) For the central bank to achieve a long-run target inflation rate of , at what rate must the money
supply grow?
Explain your answers and show all working.
[5 marks. 1 mark for each part]
Question 4
You read on a financial website that the nominal interest rate is 12 percent per year in Canada and 8
percent per year in the United States. Suppose that international capital flows equalize the real interest
rates in the two countries and that purchasing-power parity holds.
(i) What can you infer about expected inflation in Canada compared with the United States?
(ii) What can you infer about the expected change in the exchange rate between the Canadian dollar
and the U.S. dollar?
(iii) A friend proposes a get-rich-quick scheme: Borrow from a U.S. bank at 8 percent, deposit the
money in a Canadian bank at 12 percent, and make a 4 percent profit. What is wrong with this
scheme?
Explain your answers and show all working.
[ 3 marks. 1 mark for each part]
Question 5
The steady-state rate of unemployment is given by ⁄ = ( + )⁄ , where U is the number of
unemployed workers, L is the labour force, s is the rate of job separation and f is the rate of job finding.
Suppose that the unemployment rate does not begin at this level.
(i) Express the change in the number of unemployed as a function of s, f, and U.
(ii) Then show that if unemployment is above the natural rate, unemployment falls, and if
unemployment is below the natural rate, unemployment rises.
Explain your answers and show all working.
[4 marks. 2 marks for each part]
Question 6
Assume a hypothetical economy which begins in long-run equilibrium and in which banks have been
subject to a regulation that disallows them to pay interest on everyday transaction accounts, also called
checking accounts. Then assume a change in government regulations allows banks to start paying interest
on these checking accounts.
(i) How would this change affect the demand for money?
(ii) What would happen to the velocity of money?
(iii) If the central bank keeps the money supply constant, what would happen to output and prices in
the short run and in the long run?
(iv) If the goal of the central bank is to stabilize the price level, should the central bank keep the money
supply constant in response to this regulatory change? If not, what should it do? Why?
(v) If the goal of the central bank is to stabilize output, how would your answer to part (iv) change?
Explain your answers and illustrate using appropriate diagrams.
[5 marks. 1 mark for each part]


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