Prof.
Giovanna Vallanti TA: Diletta Topazio
LUISS dtopazio@[Link]
Macroeconomics
Academic Year 2023 2024
PROBLEM SET 1 - Due on Wednesday the 27th of September by 16:00
Please upload a single file in PDF format.
Data and National Accounting
• Exercise 1
There are 100 million working-age individuals in the economy. Of these 100 million, 50 million are
currently working, 10 million are looking for work, 10 million stopped looking for work 2 months
ago, and the remaining 30 million do not want to work.
1. Calculate the number of unemployed individuals, the size of the labour force, the unemploy-
ment rate, and the participation rate.
2. Now suppose that of the 10 million individuals looking for work, 5 million stop looking for
work (discouraged individuals). Given this change, calculate what will happen to the size of
the labor force, the unemployment rate, and the participation rate. Do the unemployment
rate and the participation rate move in the same direction? Explain.
3. Now use again the original numbers. Suppose firms experience an increase in the demand for
their products and respond by increasing employment. Specifically, 2 million of the previously
unemployed individuals now have jobs. Given this change, calculate what happens to the
size of the labour force, the unemployment rate, and the participation rate.
4. If discouraged workers were officially counted as unemployed, explain what would happen to
the size of the labour force, the number of employed individuals, the number of unemployed
individuals, the unemployment rate, and the participation rate.
• Exercise 2
Define nominal GDP and real GDP and then aswer the following questions
1. is it possible for nominal GDP in a year to be less than real GDP in the same year? Explain.
2. is it possible for nominal GDP to increase and real GDP to decrease in the same period.
1
Goods Market
• Exercise 3
Suppose consumption in Italy is represented by the following equation:
C = 200 + 0.5YD
where YD is disposable income. Net taxes (T ) are equal to 200.
1. What is the level of consumption in this economy if YD = 0? Briefly explain how individuals
”pay” for this consumption when YD = 0.
2. Given the above parameters, calculate the level of consumption if Y = 1, 200. Suppose Y
rises to 1, 300. What happens to the level of consumption?
3. Write down the savings function for this economy. What is the level of savings when YD = 0?
Explain how and why it occurs. What is the marginal propensity to save for this economy?
• Exercise 4
The marginal propensity to consume represents
a. the level of consumption that occurs if disposable income is zero.
b. the ratio of total consumption to disposable income.
c. total income minus total taxes.
d. the change in output caused by a one-unit change in autonomous demand.
e. the change in consumption caused by a one-unit change in disposable income.
Briefly explain your answer.
• Exercise 5
Which of the following is an exogenous variable in our model of the goods market in Chapter 3?
a. consumption (C)
b. saving (S)
c. disposable income (YD)
d. government spending (G)
e. none of the above.
Briefly explain your answer.
• Exercise 6
So far we have assumed that the fiscal policy variable T is independent of the level of income.
In the real world, however, this is not the case. Taxes typically depend on the level of income,
and so tend to be higher when income is higher. Here we examine how this automatic response
of taxes can help reduce the impact of changes in autonomous spending on output. Consider the
following model of the economy:
2
8
< C = c 0 + c 1 YD
Y =Y T
: D
T = t0 + t1 Y
G and I¯ are both constant.
1. Is t1 greater or less than 1? Explain.
2. Solve for equilibrium output.
3. What is the multiplier? Does the economy respond more to changes in autonomous spending
when t1 is zero or when t1 is positive? Explain.
4. Why is fiscal policy in this case called an automatic stabilizer?
5. Now solve for taxes in equilibrium.
6. Suppose that the government starts with a balanced budget and that there is a drop in c0 .
What happens to Y ? What happens to taxes?
• Exercise 7
Suppose an economy is represented by the following equations:
8
>
> Z =C +I +G
>
>
>
> C = 300 + 0.5Yd
>
>
>
<Y = Y T
d
>
> T = 400
>
>
>
>I = 200
>
>
>
:G = 1, 000
1. Calculate the equilibrium level of output. Draw on a graph (Y, Z) the demand curve. Using
the 45 degree line derive the equilibrium level of output.
2. Suppose that after en exogenous shock to demand (for example an increase in consumer
confidence) autonomous consumption (c0 ) increases from 300 to 400. Determine the variation
in output and the multiplier in this economy.
3. Illustrate graphically the e↵ect of the increase in c0 calculated in point (b) and explain why
the increase in output is greater than the initial increase in consumption.
• Exercise 8
Governments are often reluctant to run budget deficits. Here we examine whether policy changes
in G and T that maintain a balanced budget are macroeconomically neutral. Put in another
way, we examine whether it is possible to a↵ect output through changes in G and T so that the
government budget remains balanced. Consider the following equation:
1
Y = (c0 + I¯ + G c1 T ).
1 c1
3
1. By how much does Y increase when G increases by one unit?
2. By how much does Y decrease when T increases by one unit?
3. Why are your answers to points (a) and (b) di↵erent?
4. Now suppose that the economy starts with a balanced budget, i.e. T = G, and that G and
T increase by exactly one unit. Using your answers to points (a) and (b), what is the change
in equilibrium GDP? Are balanced-budget changes in G and T macroeconomically neutral?
5. How does the propensity to consume a↵ect your answer? Why?
• Exercise 9
Which of the following events will cause a reduction in equilibrium output?
1. (A) an increase in the marginal propensity to save
(B) an increase in taxes
(C) a reduction in the marginal propensity to consume
(D) all of the above
(E) none of the above
Briefly explain your answer
• Exercise 10
To answer this question, assume that both government spending and taxation are exogenous, while
both consumption and investment spending are endogenous. An increase in government spending
entirely financed by a tax cut will cause:
1. a. a reduction in consumption in equilibrium since disposable income is lower
b. an increase in the level of investment in equilibrium
c. an increase of the in the overall level of production and income in equilibrium
d. no changes in autonomous spending
Either no or more than one option can be true. Indicate the correct option(s) only and briefly
explain your choice.