Explain your answer with the aids of ONE diagram for the s and ONE diagram for the rental market for capital.

Question 1 (20 points) – Topic 1 (save your answer as HW1-Q1.pdf)

The following table provides the economic data for an economy.

Year 2019 2020 2021

Price Quantity Price Quantity Price Quantity

Good 1 32 80 36 120 34 110

Good 2 11 150 13 160 15 180

Good 3 43 40 44 50 50 60

Good 4 51 160 58 240 54 180

Good 5 22 85 20 80 23 90

Good 6 8 340 9 360 6 320

Here is some additional information about this economy that holds true for all 3 years:

• Unless otherwise stated, the goods are produced within the economy and the goods are consumed by

local sectors.

• Good 1 is a pure consumption good. Domestic households purchase three-fifths of that good while

the remaining goes to foreign households.

• Both households and firms purchase good 2, in which households buy 80% of that good. In addition,

half of the good 2 consumed by businesses is produced outside the country.

• Residents purchase all good 3, and a quarter of them is purchased from abroad.
• Firms consume half of good 4 while the government purchase 30% of them. The rest is bought by

foreign businesses.

• The share of good 5 consumed by households, firms and government are 40%, 40% and 20%

respectively.

• Half of good 6 goes to the government while the remainder is equally split between households and

firms. However, the country does not produce a single unit of the good.

• The government has chosen 2020 as the base year. In the base year, both the GDP deflator and the

CPI are nominalized to 100.

Based on the information given, complete the following table.

2019 2020 2021

(Nominal) Consumption

(Nominal) Investment

(Nominal) Government spending

(Nominal) Exports

(Nominal) Imports

Nominal GDP

Real GDP

GDP deflator

Cost of consumption basket (in CPI)

CPI

Note:

• The above table is reproduced on page 3 of this assignment (so that you can print it & fill it out).

You must submit that page as your answer to Question 1 with your assignment for grading.

• Also, on separate page(s), show your work! You are required to do both; otherwise, you will receive

a grade of zero for this part of the question. Keep your answer to 2 decimal places if needed.

MGEB05 Assignment 1 (Fall 2022) 3

Submit this page for grading; otherwise, you will receive a grade of ZERO for

Question 1.

2019 2020 2021

(Nominal) Consumption

(Nominal) Investment

(Nominal) Government spending

(Nominal) Exports

(Nominal) Imports

Nominal GDP

Real GDP

GDP deflator

Cost of the consumption basket

(in CPI)

CPI

MGEB05 Assignment 1 (Fall 2022) 4

Question 2 (30 points) – Topic 2 (save your answer as HW1-Q2.pdf)

A closed economy can be described by the long-run classical model:

Y = 2K

0.5L

0.5

C = 950 + 0.5(Y – T) – 70r

I(r) = 3000 – 30r

MPK = K

–0.5L

0.5 MPL = K0.5L

–0.5

Note: r is measured in percentage points (i.e., if r = 5, then r = 5%). Keep your answer to 3 decimal

places if needed.

The economy is endowed with 625 units of capital and 10000 workers. Initially, the government collects

14% of output as income taxes and it runs a budget surplus of 100.

1. a) Find the equilibrium levels of output, real interest rate, and investment. Also, find the long-run

equilibrium real wage for labour and real rental price of capital. (5 points)

Suppose the business confidence index changes from 113 to 115. As a result, autonomous investment

changes by 4%.

Note: you will need to decide whether autonomous investment increases or decreases.

1. b) Find the new equilibrium levels of real interest rate, investment, and real rental price of capital. (5

points)

1. c) Show your answers for parts (a) & (b) in three diagrams (that depict the loanable funds market, the labour market, and the rental market for capital in long-run equilibrium). Be sure to identify which

points on your diagrams are the long-run equilibria for part (a) & (b) respectively. No written

explanation is required. (9 points)

1. d) (Continued from part b) Suppose the government wants to keep the (equilibrium) level of

consumption to 1798 via a change in government spending. Find the level of government spending

that could achieve this goal. What happens to the budget balance (i.e., increase or decrease, and by

how much)? (6 points)

1. e) (Ignored part (d)) Now, consider what happens to the economy in the very long-run. Based on your answer in part (b), what happens to the stock of capital and level of output in the very long-run?

Explain in words only. (5 points)

Question 3 (30 points) – Topics 2 & 3 (save your answer as HW1-Q3.pdf)

Suppose Canada is a closed economy and in its long-run equilibrium initially. The government increases

its subsidy to capital investment projects. At the same time, the shortage of computer

chips/semiconductors forces many manufactures to delay their spending on replacing depreciated

machinery and equipment.

In the context of the long-run classical model, examine the effects of the above events on the following

variables in the long run:

• output
• real interest rate
• national savings
• real rental price of capital
• price level

Explain your answer with the aids of ONE diagram for the market of loanable funds and ONE diagram

for the rental market for capital.

MGEB05 Assignment 1 (Fall 2022) 5

Question 4 (20 points) – Topics 2, 3 & 4 (save your answer as HW1-Q4.pdf)

Each part of the question is NOT related to other parts and each part is worth 5 points.

1. a) Suppose a closed economy experiences a skill-biased technological change and, at the same time, a

slowdown in the pace of educational advancement reduces the supply of skilled workers. According

to neoclassical theory of distribution what happens to the real wages of skilled workers? Explain and

support your answer with ONE labour market diagram for the skilled workers.

1. b) “When the aggregate price level rises faster than initially expected, borrowers with unindexed

contracts will find their real interests paid on loan turn negative.” True/False/Uncertain, explain.

1. c) Surveys by different polling organizations show that the public expects the prices will continue to

rise at the pace that is faster than before. If the overall price level is determined in the money market,

what happens to today’s overall price level after the release of these survey results? Explain.

5000. d) The economy is in its long-run equilibrium with the size of the labour force is 5000. If the number

of workers who are actively looking for job is 500 and the number of unemployed workers who find

themselves a job in each month is 270, find the job separation rate.

Note: Keep your answer to 3 decimal places if needed