Introduction to Macroeconomics: Take-Home Assignment

Deadline: 3 pm, 20th April 2016 (for all the three groups)
Location: Alexandra Graviers office
This homework contains two questions. Each question is worth 10 points. You can
work individually or in a group of 2. If you work in a group of 2, you need to submit one
hand-written solution with your names on it. Please be concise in your answers.

Mutations of the Phillips curve, Supply shocks and Wage flexibility

Suppose that the Phillips curve is given by
t = te + 0.1 2ut

(1)

For notations, read your seminar notes.

1. What is the natural rate of unemployment? Derive it mathematically.
Assume that
te = t1

(2)

and suppose that is initially equal to 0. Suppose further that the rate of unemployment is initially equal to the natural rate. In year t, the authorities decide to bring
the unemployment rate down to 3% and hold it there forever.
2. Determine the rate of inflation in years t, t + 1, t + 2 and t + 5.
3. Do you believe the answer given in 2? Why or why not?
Now suppose that in the year t + 5, increases from 0 to 1. Suppose that the
government is still determined to keep u at 3% forever.
4. Why might increase in this way?
5. What will the inflation rate be in years t + 5, t + 6, and t + 7?
6. Do you believe the answer given in 5? Why or why not?

Suppose now that I rewrite the Phillips curve in the following manner
t t1 = (ut un )

(3)

where
un =

( + z)

(4)

Recall that this Phillips curve can be derived under the assumption that the wagebargaining and price-setting equations took the following form (as in the seminar
presentation)
W = P e (1 ut + z)

(5)

P = W (1 + )

(6)

You can interpret as a measure of wage flexibility- the higher the greater the
response of the wage to a change in the unemployment rate, ut ,
7. Suppose = 0.03 and z = 0.03. What is the natural rate of unemployment if = 1?
If = 2? What is the relation between and the natural rate of unemployment?
Interpret your answer.

Playing with the Solow model1

Suppose that the production function is given by

Y = 0.5 K L

(7)

1. Derive the steady-state level of output per worker and capital per worker in terms of
the primitives of the model (i.e. the savings rate, and the depreciation rate)
2. Derive the equation for steady-state output per worker and steady-state consumption
per worker in terms of s and
3. Suppose that = 0.05. Using Excel, compute steady-state output per worker and
steady-state consumption per worker for s = 0, s = 0.1, s = 0.2, s = 0.3 ... s = 1.
Explain the intuition behind your results.
1

For this question, please print out your answers to 3 and 4 from Excel and attach it with your solutions.

4. Using Excel, graph the steady state level of consumption per worker as a function of
the saving rate (i.e., measure the saving rate on the horizontal axis of your graph and
the corresponding values of output per worker and consumption per worker on the
vertical axis).
5. Does the graph show that there is a value of s that maximizes output per worker? Does
the graph show that there is a value of s that maximizes consumption per worker? If
so, what is this value?