ECON 6002 Final Assessment Guidelines
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Final Assessment Guidelines
ECON 6002
Material Covered and Expectations:
1. The final assessment will cover material from the whole course, although focusing mostly on material since the midterm assessment. Anything covered in class, in the tutorials, or in the problem sets is potentially assessable.
2. You will be provided with relevant formulas such as production functions to be used in answering a question (see questions below for examples of what sort of material will be provided and what you might be assumed to know).
3. You will be expected to understand and interpret the “economics” behind any equations provided.
4. In answering algebraic/numerical questions, be precise, showing all of the steps, and indicate if you are making any assumptions along the way. Report answers to 2 decimals (unless otherwise stated) and put a box around your final answer.
5. Answers must be in your own words. Use quotations when referencing textbook, lecture, or tutorial material.
6. You must complete the assessment on your own. Do not collaborate in any way.
7. Questions will be personalized based on your student ID. Specifically, you will be asked to write out your student ID number, which will be cross-checked with your submission and used to provide parameter values or assumptions when solving certain questions.
8. You will be given 15 minutes after the 2 hour assignment to scan/convert your answers to a pdf and upload under the upload assignment link for the final assessment assignment link.
9. I will not post solutions for the questions below because closely related questions may show up in the assignment. You should be able to come up with your own solutions using the lecture slides, textbook, tutorial solution videos, and answer key for the problem set. Doing so will be good preparation for the assignment. But it is not sufficient as there will be different questions.
Example Questions:
1. Consider the Romer model and note the equilibrium output (per capita) growth is max { B _ (1 _ φ)ρ, 0}.
(a) Why, in economic terms, would the output growth rate increase in (1 _ φ), B, and ?
(b) The Romer model is a microfounded model of endogenous growth. Explain why endo- genizing growth in the Romer model requires deviation from the assumption of perfect competition?
(c) Provide an empirical example that supports the importance of population growth for economic growth.
(d) Why do Canada and the United States have similar growth despite very different pop- ulations?
(e) Explain in words why the decentralized equilibrium in the Romer model is socially suboptimal.
2. Consider a simple Taylor rule with an inflation target of zero: it = + φππt + φyy˜t, where it is the nominal interest rate, > 0 is the natural real interest rate, πt is inflation, and y˜t is the output gap. The aggregate demand and supply equations are given by t = _β(rt-1 _ ) + ρy˜t-1 + εt(D) and πt = πt-1 + αy˜t + εt(S), where εt(D) and εt(S) are demand and supply shocks, respectively. The relationship between it and rt is given by the Fisher identity (assuming expected inflation is equal to current inflation): rt = it _ πt . All parameters (, φπ, φy, β, ρ, α) are > 0. Further, assume that the following parameters (α, β, ρ, φy < 1). Suppose that there is one-time 10% supply shock at time t = 0 so that ε0(S) = 0.1. There is no further demand or supply shock after t = 0. Assume that prior to t = 0, the economy was in steady state with i = , π = 0, y˜ = 0, and r = .
(a) Solve for inflation and the output gap at t = 0 and 1 (i.e., π0 , π 1 , y˜0 , y˜1 ) as functions of
model parameters (or compute the exact values if available).
(b) Suppose that φπ s 1. Show that y˜1 > y˜0 > 0 and π 1 > π0 > 0.
(c) Suppose that φπ > 1. Show that it is possible to stabilize inflation after only one period (i.e., π 1 = 0). At what value of φπ would this occur?
(d) What can you say about the role of the value of φπ for inflation stabilization? But what is the cost of a higher ratio of φπ/φy?
3. Consider the delegation problem under discretionary policy. Suppose social loss minimization implies π = π * + (y* _ yflex ) + (πe _ π * ), while loss minimization for a “hawkish” central banker with a\ > a implies π = π * + (y* _ yflex ) + (πe _ π * ). Let π * , π EQ , and π EQ\ be equilibrium inflation under rule-based policy with commitment, discretionary policy without delegation, and discretionary policy with delegation, respectively.
(a) Show, mathematically, that π * < πEQ\ < πEQ .
(b) Show the result in (a) graphically. You should compute the precise slopes and intercepts (i.e., when π e = 0) for both discretionary policies (with and without delegation).
(c) What value of a\ would imply that the equilibrium inflation rate under discretionary policy with delegation is equal to the inflation rate under rule-based policy with com- mitment? Would this be a good value if the true social loss function (i.e., the loss function corresponding to household preferences) has the relative weight on inflation stabilization equal to a? How does your answer depend on assumptions about shocks hitting the economy?
(d) Suppose the central banker’s true preferences regarding inflation match the social welfare function (i.e., the parameter on squared inflation deviations in the loss function is a < a\ ), but private sector agents believe the central banker is “hawkish” with parameter a\ when inflation is determined. Is social welfare higher if the public is wrong about the central banker’s preferences or if the central actually is “hawkish”, as assumed in parts (a)-(c). Explain your reasoning.
4. Consider the “Q” model of investment with adjustment costs. Equilibrium suggests that capital K(t) evolves as K˙ (t) = C\-1 (q(t) _ 1) (normalizing the number of firms N = 1 and assuming no depreciation), while the marginal value of capital, q(t) evolves as q˙(t) = rq(t) _ π(K(t)), where r is the real interest rate. Note that the capital adjustment cost function, C(I(t)) satisfies C(0) = 0, C\ (0) = 0, and C\\ (.) > 0 and the real profit function, π(K(t)), satisfies π \ (.) < 0. Assume the transversality condition limtAo e-rtq(t)κ(t) = 0, where κ(t) is the representative firm’s capital stock.
(a) Draw the phase diagram for this model, explaining the location of the saddle path.
(b) Use the phase diagram to show what happens given a sudden permanent drop in demand for output in a given industry. Explain what happens to q and K in that industry. What happens to the relative price of the industry’s output, as well as profits and the market value of capital, both on impact and over time?
(c) Compare your results in part (b) to what would happen if the drop in demand were only temporary. Does q jump by more or less than in the case of a permanent drop? Why can’t there be any anticipated jump in q after the initial fall?
(d) Comparing the results for parts (b) and (c), what do they imply about the effects of future changes in output on current investment for this industry? (Hint: in which case is the accelerator effect larger?)
2023-05-12