ECON2420 MACROECONOMY & BUSINESS CONDITIONS
PROBLEM SET (TOTAL MARKS: 100)
DUE: 16 SEPTEMBER 2022 10:00AM
This is an open-book problem set. You are NOT allowed to ask anyone but you are
welcome to do your own research and write your own answers. You have 24 hours to
complete AND submit your answers by the due time. Handwritten as well as typed an-
swers are welcome. Make sure that you upload a single PDF file containing multiple pages.
Question 1 (10 marks) Explain how the inflation measured according to the CPI and
GDP deflator may differ.
Question 2 Consider the equilibrium equation in the goods market:
Y = c0 + c1(Y − T ) + I¯ + G¯,
where:
Y is the real domestic output,
T is the tax revenue,
I¯ is the exogenous investment spending,
G¯ is the exogenous government spending,
c0 is the consumption spending independent from Y , and
c1 is the Marginal Propensity to Consume (MPC), with 0 < c1 < 1.
The on-going war between Russia and Ukraine has created economic uncertainty around
the globe, shifting the consumption spending.
Assume that:
(i) the Australian households now choose to save more, i.e., increase in the marginal
propensity to save (MPS) during this uncertain period, ceteris paribus.
(ii) Australian government is running a balanced budget, i.e. G = T .
Explain and illustrate graphically the effect of the increase in the MPS on:
(a) (5 marks) The total demand line (ZZ). Show clearly the effect on the intercept with
the vertical axis and the slope.
(b) (5 marks) The autonomous spending.
(c) (5 marks) The multiplier.
Question 3 Answer the following questions:
(a) (5 marks) What does the unemployment rate measure? Explain briefly.
1
(b) (10 marks) A large number of 60 year-old currently employed workers choose to retire
now. How does this affect the labour force participation rate and the unemployment
rate? Explain.
Question 4 Read this article from the conversation (click on the link):
Grattan on Friday: Should Anthony Albanese keep his word on the stage 3 tax cuts?
The equilibrium of the goods market is given by:
Y = C + I + G.
Consider the following behavioural equations:
C = c0 + c1YD
T = t0 + t1Y
YD = Y − T.
Here, G and I are constant. Assume a closed economy and that 0 < c1 < 1, 0 < t1 < 1,
c0 > 0, and t0 > 0.
Based on the article from the conversation, if the stage-3 tax cut becomes effective,
ceteris paribus, answer the following questions.
(a) (5 marks) How does it affect parameters c0, c1, t0, and t1?
(b) (5 marks) How does it affect T , YD, Y and C?
(c) (5 marks) Would the economy (Y ) then respond more or less to changes in au-
tonomous spending? Explain.
(d) (5 marks) Based on your answer in part (c), how the effectiveness of the automatic
stabiliser is affected by the stage-3 tax cut?
Question 5 Consider the model of supply and demand for central bank money. Assume
that there there are commercial banks. Suppose that people hold 20% of their money
in currency and 80% of their money in deposits. The central bank sets the reserve-to-
deposit ratio at 10%. In the first period, the central bank increases the supply of money
by $200, buying bonds through Open-Market Operations. Use this information to answer
the following questions:
(a) (10 marks) For the second period (after the central bank has injected $200 in the
economy), calculate: (i) the demand for currency, (ii) the amount of deposit held at
the commercial banks, (iii) the demand for reserves held at the central bank, and
(iv) the demand for the high-powered money. How much is the additional money
supply created at the end of the second period?
2
(b) (5 marks) How much is the additional money supply created at the end of the third
period?
(c) (5 marks) As time continues, additional money supply will be created. Calculate
the total increase in the money supply as a consequence of the initial $200 increase
in the money supply by the central bank.
Question 6 Read this article from the Conversation (click on the link):
Government to legislate for multi-employer bargaining, strengthening push for wage
increases
Assume the following scenario:
(i) The Reserve Bank of Australia (RBA) uses the interest rate rule to respond to
deviations from the targeted inflation (P − P T ).
(ii) To simplify the analysis, ignore the increase in cost of living referred to in the
article. That is, assume that there has not been an initial shock causing an
increase in prices.
Use the IS-LM model, the wage-setting and price-setting models, as well as AD-AS
models, to explain (both graphically and in words) the effects of this legislation on:
(a) (10 marks) Output level, interest rate, and price, in the short-run.
(b) (10 marks) Output level, interest rate, and price, in the medium-run.
3