The Relationship between Education, Labor Force, and Income
1. The amount of education the typical person receives varies substantially among countries. Suppose you were to compare a country with a highly educated labor force and a country with a less educated labor force. Assume that education affects only the level of the efficiency of labor. Also assume that the countries are otherwise the same: they have the same saving rate, the same depreciation rate, the same population growth rate, and the same rate of technological progress.
Both countries are in their steady states. What would you predict for the following variables?
a. The rate of growth of total income
b. The level of income per worker
c. The real rental price of capital
d. The real wage
2. Choose two countries that interest you—one rich and one poor. What is the income per person in each country? Find some data on country characteristics that might help explain the difference in income: investment rates, population growth rates, educational attainment, and so on. (Hint: The Web site of the World Bank, www.worldbank.org is one place to find such data.) How might you figure out which of these factors is most responsible for the observed income difference? In your judgment, how useful is the Solow model as an analytic tool for understanding the difference between the two countries you chose?
3. Chapter 9 discussed the importance of the rate of saving, and more importantly, how those savings dollars are utilized in the economy, on the rate of economic growth. In previous weeks, we have discussed the trends in saving and consumption in the US economy. What are the implications of those trends on the future of the US economy? What predictions would you make for US business and industry as a result? What kinds of policies would you suggest to alter the course toward one of more sustained economic growth? What role might business and industry play in the long term sustainability of the US economy?
4. Standard economic theory has for a long time lauded the economic benefits of free trade through specialization and comparative advantage. Considering the free flow of ideas and lower trade barriers, how might the recent trends in globalization have contributed to the stagnating rates of investment in the US and similar countries? What kinds of international mechanisms and/or policies might be needed to support business investment?
5. An economy begins in long-run equilibrium, and then a change in government regulations allows banks to start paying interest on checking accounts. Recall that the money stock is the sum of currency and demand deposits, including checking accounts, so this regulatory change makes holding money more attractive.
Analyzing Two Countries with Different Income Levels
a. How does this change affect the demand for money?
b. What happens to the velocity of money?
c. If the Fed keeps the money supply constant, what will happen to output and prices in the short run and in the long run?
d. If the goal of the Fed is to stabilize the price level, should the Fed keep the money supply constant in response to this regulatory change? If now what should it do? Why?
e. If the goal of the Fed is to stabilize output, how would your answer to part (d) change?
6. The official arbiter of when recessions begin and end is the National Bureau of Economic Research, a nonprofit economics research group. Go to the NBER’s Web site (www.nber.org) and find the latest turning point in the business cycle. When did it occur? Was this a switch from expansion to contraction or the other way around? List all the recessions (contractions) that have occurred in the past 25 years and the dates when they began and ended.
7. Historically, there tends to be an inverse relationship between the rate of inflation and the rate of unemployment (often illustrated by the Phillips Curve), with few exceptions.
a. Briefly explain the underlying causes behind this relationship.
b. In the 1970s, the US economy displayed two periods of both high inflation (in the double-digits),and high unemployment, called stagflation. What were the unique events/trends taking place which led to this unusual phenomenon? Use the model of aggregate supply and aggregate demand to help explain your answer.
c. In the 1990s, the US economy experienced the opposite, as both inflation and unemployment rates were at historic lows. What were the key events/trends which led to this unusual outcome? Use the model of aggregate supply and aggregate demand to help explain your answer.
d. In the current [sluggish] recovery, do we see the typical relationship hold? Why or why not? What kinds of policies might help? What might be some of the unintended consequences?
8. Some economists believe that taxes have an important effect on the labor supply. They argue thathigher taxes cause people to want to work less and that lower taxes cause them to want to work more. Consider how this effect alters the macroeconomic analysis of tax changes.
a. If this view is correct, how does a tax cut affect the natural level of output?
b. How does a tax cut affect the aggregate demand curve? The long-run aggregate supply curve? The short-run aggregate supply curve?
c. What is the short-run impact of a tax cut on output and the price level? How does your answer differ from the case without the labor-supply effect?
d. What is the long-run impact of a tax cut on output and the price level? How does your answer differ from the case without the labor supply effect?