Questions about course content for Econ 102, Section 100, Winter 2004: Apr 30: > Thanks for speedy response, I appreciate it. However, I do not understand > how for #28 on Form 0 of the 2004 Final Exam, either A or B (apparently A, > because you said B is not correct) is describing the same situation as C, > the answer. If A and B are opposites, then doesn't one of them have to be > concurrent with C?? It was too speedy, perhaps. I didn't go back and look at the exam question, but just responded to what you said in yours. What PPP means is that the exchange rate adjusts so as to exactly offset any effects that changes in price levels would otherwise have on the relative prices of goods. That is, PPP assures that the exchange rate adjusts to prevent both a and b from happening; that is, so that foreign goods and services remain constant in their price relative to U.S. output. With foreign prices rising more slowly than US prices, the dollar must depreciate to achieve this. Apr 30: > I have a question about one of the problems on the final exam, as I just > saw the answer key. For question 30, it asks: which of the following is > better to do before, rather than after an increase in the money supply? > I answered "buy a car on credit," because your payment for the car is > post-poned, and its nominal value will be the same on your credit card > bill. When you do have to pay for the car in the future, you will be > paying with less valuable dollars (due to the increase in money supply), > so the car doesn't cost as much in real terms. The correct answer in the > solution key was "buy bonds," and I understand the logic behind that > answer as well, but I'm confused why buying a car on credit would not > also be a correct answer. Because the short-run effect of the increase in the money supply is to lower the interest rate (see the short-run money market). If you buy the car now, you will get a car loan at an higher interest rate than you could have gotten later. Apr 30: > I have a question about one of the questions on the exam because it > was very similar to a question on one of the previous final exams (which > were available to practice with), however the answers were different. On > the 2002 Final Exam Question 5 (Form 1) says that answer is C. "an > inflation rate that is very high but constant", but on this Final Exam > 2004, the answer to number 19 on Form 0 says the answer is D. > "Accelerating inflation". On the 2002 Exam "accelerating inflation" was > an option, but it was not correct. It actually was correct, and the posted answer on the old exam was wrong. A typo, apparently. I confirmed this in response to a posted question on Apr 26. > Also, on number 28 of Form 0, I believe that B and C are describing > similar situations so I was forced not to pick C, depreciation of the US > dollar would make foreign goods and services become cheaper relative to > U.S. output, no? No, just the opposite. Depreciation of the US dollar makes the dollar itself cheaper, and thus makes US goods cheaper also, relative to goods produced elsewhere that are priced in other currencies. Apr 27: > This is from Practice Exam 2003, question 36. > The question is: "Disinflation" is caused by > a) expanding the money supply less rapidly than money demand > b) falling prices > c) a rate of unemployment that is higher than the natural rate of unemployment > d) a real rate of interest that is higher than the nominal rate of interest > e) taxation of dividends > I understand why C works as an answer, but why wouldn't A also work? If > MS expands less than MD, then r will go up. If r goes up, this is like a > shift left of the AD curve, which is a lot like what happens when you > keep unemployment higher than the natural rate. It looks the same on the > AD/AS curve. If the money keeps growing less rapidly, I would think the > P keeps falling, and inflation would decrease. In fact, isn't that what > Volker did in his disinflation? Growing MS less than GDP is a lot like > growing it less than MD, because MD and GDP can be very similar. Your reasoning is correct, but it assumes a couple of things that are not stated. You don't know here that the economy starts from the natural rate of unemployment. If it started below that -- i.e., in a boom -- then the shift of AD that you describe would only take you back toward YN, not necessarily past it, and therefore not necessarily causing disinflation but only reducing the acceleration of inflation. Second, you assume that "expanding the money supply less rapidly than money demand" continues on into the future. I agree that if this happened, then eventually unemployment would be pushed above the natural rate and disinflation would ensue. But the statement in (a) does not say that. Therefore, (c) is the the better answer. Apr 27: > I have a question on # 24 Winter 2003. Why is c) wrong? > it says the natural rate of unemployment is expected to decline over the > next few years. I thought it would shifts the LR philips curve to the > left and hence increased the inflation. What's wrong with that? A fall in the natural rate of unemployment would indeed shift the LR Philips curve to the left. But that means that any given actual rate of unemployment is further above it, causing expected inflation to fall more rapidly and making it easier to reduce the inflation rate. Apr 27: > 1) What is the relationship between the change in Money Supply and > Nominal/real exchange rate in the short run and long run? An increase in the money supply will cause the currency to depreciate in both the short run and the long run. This should be very clear for the long run, where the increase in money causes the price level to rise (through the quantity theory) and therefore, due to PPP, causes the currency to depreciate. In the short run we haven't focused on this so carefully, but the result is the same through a different mechanism: The rise in the money supply causes the interest rate to fall in the short-run money market. This causes a capital outflow, which causes the depreciation. There is however an important difference in these two. In the short run this depreciation is a real depreciation, since it occurs in the absence of an equal rise in the price level. In the long run the nominal depreciation is equal to the price increase, and it is thus preventing any change in the real exchange rate. > 2) MS does not affect price level and inflation in the short run. Is that > correct? No, that's not correct. A rise in the money supply shifts aggregate demand to the right (due to its effect on the interest rate and thus investment), and equilibrium moves up the SRAS curve. So price rises. > 3) Is the MV=PY model short run or long run? As a model, which assumes that velocity is constant, this is valid only in the long run. > 4) How does change in government spending affect short-run int. rate? It increases it. It does this by expanding aggregate demand, shifting the AD curve to the right, thus increasing both Y and P, which raises the demand for money and thus, in the short-run money market, increasing the interest rate. Apr 26: > I was doing Econ 102 past exam Winter 2002 and I was stuck on # 5. I > thought when policy makers try to lower unemployment rate from 8% to 4%, > it will have an accelerating inflation. Yet, the answer is c. an > inflation rate that is very high but constant. Can you tell me the reason > behind?? You are right, and the answer posted is wrong. I don't know what happened. Apr 26: > When expected price increase, is it the nominal or real wages that > increase too? Nominal. > For sticky wages, it is the real wage that decreases when > prices increase (thus increaseing output-slope upwards) because nominal > wage is constant. Yes. > When nominal wages adjust themselves, shouldn't real > wages be constant and thus when expected price increases, it is the > nominal wage that increases? Yes. It is because nominal wages rise by the same amount as expected prices that real wages and output do not change -- that is, the SRAS curve shifts straight up. > So...why is it in the sticky wage theory, the real wage matters and when > wages adjust themselves, the nominal wage matters? Because for given expectations the nominal wage (not the real wage) is failing to move when the price changes, and the nominal wage is thus sticky. Apr 26: > Hi! I just happened to come across a question in the previous homework > that is confusing. Um...so..it's question number 4 of Homework #8. So, it > says that NOW we are in a situation where unemployment is below the > natural rate. I looked at the solution guide and the graph illustrated > shows that the SRAS curve shifts leftward or up to a point of new > long-run equilibrium. Well, what I don't understand are the answers to > the questions, (a) through (f). I believe you mentioned in lecture that > the SRSA curve shifts (expections of consumers changing)in the long-run. > But, if you think about the subquestions (a) through (f) in the long-run > perspective, the answers are not quite the same. I haven't looked at the posted answers yet, but I suspect you are trying to compare what happens here, where we start from being NOT in a long-run equilibrium, to the effects we had earlier in the course for moving from one long-run equilibrium to another. They are different questions and therefore have different answers. > For example for (b) > about the interest rate, if we were talking about the long-run effect on > interest rate, wouldn't we have to consider the Quantity theory of money > model to explain this question? (The model with the value of money (1/p) > on the vertical axis and Quantity of money on the horizontal axis.) > Wouldn't the demand for money rise and therefore, the value of money > rise, which results in a fall in price level? The demand for money does rise as a result of the rise in the price level, and in the model of the short-run money market, this causes the interest rate to rise. The quantity theory can't help you here, since it assumed that the velocity of money was constant, which is not the case here, since velocity changed in the short run and must change again in moving from the short-run equilibrium to the long run. > I am really confused! For > question 4, are we looking at the shift in SRAS as a short-run or a > long-run phenomenon? Could you clarify this confusion for me? The SRAS curve moves during the adjustment FROM a short-run equilibrium TO a long run one. Until it stops moving, we are in various short-run equilibria. When it stops moving, that is a long-run equilibrium. > Also, I don't quite understand the difference b/w short-run/long-run/and very > long-run that you explained in lecture. If you could clarify these for > me, I will probably do well on your exam! Hopefully!!!! Short run is when expectations of the price level (in the AD/AS model) or the rate of inflation (in the Philips curve model) are fixed. Long run is when expectations adjust, so that actual equals expected. But in "long-run equilibrium," the quantities of factors of production, especially capital, are fixed, because not enough time as elapsed for changes in them (due to investment, in the case of capital) to accumulate significantly. In the "very long run," changes in savings and investment do cause significant changes in the capital stock. And now you'll do well on the exam. Apr 26: > I don't understand why a 10% destruction in physical capital lead to a > decrease in productivity of less than 10% and over the next few years, an > increase of productivity growth rate of more than it was before the > destruction. On the first, suppose there were a 10% reduction in all inputs. Because of constant returns to scale, that would reduce output by 10%. So if only one input (capital) falls by 10%, output will fall by less than that. And since we've now held labor constant, that is a fall in productivity (output per unit labor) of less than 10%. On the second, I'm not sure what this refers to, though it sounds like it is assuming a constant rate of investment -- that is, a constant amount of new capital being added to the capital stock per period. If so, and if there is now 10% less capital, then two things will raise the productivity growth rate. One is that the given amount of new capital is a larger fraction of the now-smaller capital stock. And the second is that, with diminishing returns, a lower capital stock per worker means a higher marginal product of capital. > What is the relationship between productivity and productivity growth? > Does an increase in capital increase productivity but lead to a decrease > in productivity growth? Yes, probably. Productivity is the ratio of output to labor. Productivity growth is the rate at which this grows over time. A larger capital stock increases output, and thus the level of productivity. But because of diminishing returns, it also means that a given amount of new capital added to this will increase output by less. Apr 26: > I am very confused when to use the money multiplier...It seems when I > went over the exercises that it can be used to multiply the initial > loans, excess reserves, deposits etc. Is there any way to make clear what > to multiple when? The money multiplier is the reciprocal of (that is, one over) the reserve ratio. Therefore the money multiplier is the ratio of the amount of deposits to the amount of reserves, when the banks are in equilibrium with the reserve ratio holding exactly. Therefore, if you know what reserves are, then you know the amount of deposits: that is the money multiplier times the amount of reserves. And if you know a change in reserves, then the change in deposits is that times the money multiplier. It does not directly tell you about loans, but you can get that indirectly: If someone adds to reserves (by, for example, depositing some cash that they previously were holding in their pocket), that act directly adds equally to both reserves and deposits. But as the banks then adjust to the fact that they now have more reserves relative to deposits than they need, they make loans, which are redepositied. In the new equilibrium, total deposits have expanded by the money multiplier times the original new deposit, while loans have expanded by that minus the original new deposit. Apr 24: > I just went through the final exam from Dec. 2000, and I missed a number > of questions because I used the formula MV=PY to find long-run growth in > the money supply. The exam answers say to use %change M + %change V= > %change P + %change Y. I'm confused because I don't remember ever using > that formula... we always multiplied them. Please clarify for me. We did, at some point, discuss how percent changes (or growth rates) of variables are related when the levels of the variables are multiplied or divided. Thus MV=PY implies, as an approximation, the relationship that you quote among the percentage changes. It shouldn't matter which you use, since they are essentially the same. I therefore don't understand how you might have gotten questions wrong by using MV=PY. If you used it correctly, you should have gotten the right answers. Apr 24: > I don't understand why an increase in the price level increase nominal > exchange rate but not the nominal interst rate. If it is only a one time > increase (thus zero inflation), shouldn't both nominal interest and > exchange rates not be affected? An increase in the (domestic) price level causes the nominal exchange rate to depreciate, not appreciate in the long run. The reason is that the equilibrium real exchange rate is unaffected (see the open economy model), and therefore from the definition of the real exchange rate the price-level increase must be matched by a depreciation. This has nothing to do with the nominal interest rate, which as you say remains unchanged since the real interest rate and rate of inflation are unchanged. > Also, according to the PPP, an increase in the price level should decrease > nominal exchange rate...this is the reverse of the answer (to hw#7). Yes, what you say is right. But I don't see it contradicted in the homework. Homework 7, in its last sentence, says exactly this. Apr 24: > How does a change in the real exchange rate affect people's willingness > to buy foreign assets? In our models, the real exchange rate is assumed not to matter for people's willingness to buy or hold foreign assets. And in fact I can't see any reason why the level of the real exchange rate should matter for that. What does matter for international capital flows is any expectation of exchange rate changes in the future, and one can easily imagine how these might depend on the level of the exchange rate in the short run. But that gets far more complex than we can manage in this course. > Also, does this change in the real exchange in the open economy model > show that PPP doesn't hold in the long run? And that the change in real > interest rate in the market for loanabnle fund mean that money neutrality > doesn't hold in the long run? A change in the real exchange rate is indeed a violation of PPP, which if it held would keep the real exchange rate constant. And our model of the open economy in the long run, because it has the real exchange rate changing in response to various shocks, does NOT assume PPP. However, I don't see any reason for thinking that a change in the real interest rate in the long-run loanable funds market means any violation of money neutrality. It doesn't happen in response to changes in the money supply, only in response to changes in real supplies and/or demands for loanable funds. Apr 23: > I was looking at the answers posted for Quiz 4, and I was surprised to > see that Problem 3 was completely different on my quiz. Question 3, part > (a), asked to give one reason why the eventual change in short-run > equililbrium GDP might be more than $10 billion, and 2 reasons why it > might be less than $10 billion. I correctly answered one reason why it > might be more (multiplier effect), and one why it might be less (crowding > out effect), but I don't remember ever discussing a second reason (why it > might be less) in recitation or lecture. Could you let me know what the > correct reasons are? Thanks. Sounds like I don't have the final versions of the quiz. I recall that the GSIs were tinkering with it, so that is likely. As for the second reason for the short-run change in GDP to be less than the increase in spending that causes it, that is just the effect of the price increase (which is in turn the three reasons that we gave for the AD curve to slope down). Apr 23: > Reading through your notes on Monetary Policy on 3/29 I came across a > statement that demand for money depends negatively on P, Y and r...how is > this true? I understand the relationship with interest rates, but doesn't > a rise in price level lead to an increase in MD? How would they be > negatively associated? One of us made a mistake. Demand for money depends positively, not negatively, on P and Y. > Also, you mentioned that short run V (velocity)depends positively on > interest rate...how does that work? Velocity is, in effect, PY/MD, where MD is money demand. Since in the short run a rise in the interest rate reduces money demand, it increases velocity. > One last question, does selling bonds increase interest rates or decrease? I assume that you are asking about open market operations by the central bank. The Fed selling bonds reduces the money supply (because the money they collect in exchange for the bonds goes out of circulation) and therefore, in the short-run money market, increases the interest rate. (Or, more directly, selling bonds reduces bond prices and thus increases interest rates.) Apr 23: > A question from exam 1 on the effects on the market for Loanable Funds: > Why does a tax credit for personal savings shift the supply for loanbale > funds to the right? There is an increase in incentive for consumers to > save, but at the expense of tax revenue of the government (government > gives out tax credit)....so shouldn't the curve shift left or have an > ambiguous result? Strictly speaking yes, and a better question about this would say either to ignore effects on tax revenues or would specify that some other tax is varied to hold tax revenues constant. But in practice, it seems likely that such a tax credit would have only a negligible effect on taxes collected, compared to its effect on private savings. Apr 21: > In completing the readings and wsj articles I have come across the > Alternative Minimum Tax many times, yet I still don't quite understand > what it is, why it is bad, who it is affecting etc. I was hoping you > might be able to give me a simpler explination of this policy. Thank you > very much. First of all, it isn't bad. The problem with it is only that because it was not indexed to inflation it is gradually starting to apply to more and more people, and this was not intended by Congress when it created it. The Alternative Minimum Tax (AMT) is a provision of U.S. tax law that sets an income tax on people without allowing many of the deductions and other tax-avoidance devices that are normally available to taxpayers. The idea is to prevent people with high incomes from using loopholes in the tax law so successfully that they pay very little tax, and it basically does this by making them pay at least some specified fraction of their income. But now, because incomes rise with inflation, the AMT is applying to more and more people. Apr 19: > Two questions: > 1. Can a policy csrried out too late in a recession ever lead to more > recession? It seems that it could only lead to accelerating inflation and > an increase in output. Yes, I think that's right. Except for the possibility that, by causing accelerating inflation that will later have to be brought down, it may lead to another policy later that will cause recession. But you are right that the policies used to end recession, if they act too late, will still always be themselves expansionary. > 2. Is there a tradeoff between inflation and unemployment only when a > recession is caused by supply shocks in the economy? It seems that a > demand shock-caused recession would not lead to any tradeoff when > policies are enacted. No, I think I would still say that there is a tradeoff. If a negative demand shock has caused a recession, then you can do nothing and let prices gradually fall (or rise less rapidly) during a period of high unemployment, or you can use expansionary policy to reduce unemployment sooner while seeing prices rise (or rise more rapidly). Apr 17: > I have two main questions concerning separate issues: > > 1. Is there a difference in effect between an increase in public desire > to save and the public's desire to hold less cash? Let's see; these two changes are not particularly related. An increase in the public desire to save means that people will save more and consume less out of a given income and at a given interest rate. That will shift the AD curve the left in the short run (since consumption is part of aggregate demand) and shift the supply of loanable funds curve to the right in the long run. I'll leave it to you to work out what other effects these changes imply. A decrease in the public's desire to hold cash has nothing to do with savings and consumption, on the other hand. Instead it says that, for a given amount of money that it chooses to hold (money demand), it wants to hold less as cash and thus more as demand deposits. Thus more of the money that is available is deposited in commercial banks, providing the reserves for money creation through the money multiplier. Thus this change causes an increase in the money supply. This reduces the interest rate in the short run, stimulating investment and shifting aggregate demand to the right. In the long run, on the other hand, the price level rises instead of any change in the interest rate, so there is no change in any real variable. So to answer your question, these two changes have very different effects in both the short run and the long run. > Also, is there a difference between the public's desire to hold less cash > due to an invention and its desire without an invention? Should MS shift > right or MD shift down? It doesn't matter why they decide to hold less cash and more demand deposits, if indeed that is what they do. But it sounds like maybe the change that you intended to ask about what not really a change in the composition of their money demand, but rather a change in the total level of their money demand. If it is the composition, then this changes the money supply as I explained above. If it is the total amount of money demanded that changes, and not its composition, then that would be a shift in the money demand curve. > 2. Is there a difference on the effects of net exports, real exchange > rate etc. between the long run and the short run? Is the open economy > model a long run or a short run model? The open economy model is a long-run model, but many of the effects that you see there also work in the short run. That is not the case for the loanable funds market part of that model, since in the short run the interest rate is determined instead by the short run money market. But although we have not been explicit about this in class (at least in lecture), the effect of the interest rate on NFI and the role of NFI in the market for foreign currency exchange works the same in the short run as in the long run. Apr 14: > Just wondering whether an increase in the private desire to save would > increase money supply (as banks can lend out more and increase the money > multiplier)and thus increse aggregate demand (shift to the right). No, definitely not. An increase in the desire to save does not increase the amount of reserves that banks have available, nor the constraint on their lending that is imposed by the reserve requirement. So the money supply cannot change. > Or, would the increase in the desire to save decrease aggregate demand > (shift to the left) since consumption decreases. Yes, exactly. Apr 14: > After reading an article in the WSJ which cited productivity growth and > outsourcing as causes for the lack of hiring during this recovery period, > I started thinking about the implications on the natural rate of > unemployment. Could these two factors raise the natural rate? It seems to > me that we could reach the natural rate of output while using less > domestic workers. Is this the case? or are the natural rates of output > and unemployment less related, or differently related than this reasoning > would assume? Good question. You are right that if the natural rate of output were somehow fixed, then productivity improvement and/or outsourcing could let us achieve it with fewer workers, lowering the corresponding natural rate of employment and increasing the natural rate of unemployment. But the natural rate of output is not fixed. It is defined simply as the amount of output we can produce at the natural rate of unemployment. And the latter is defined in terms of various frictions and dynamics within the labor market. So if outsourcing and productivity improvement do not impact directly on the functioning of the labor market, then the natural rate of unemployment will not change, and the natural rate of output will correspondingly rise, since the same number of workers will be able to produce more. The real question, then, is whether there is anything about outsourcing and/or productivity improvement that may directly change the working of the labor market so as to change the natural rate of unemployment. In the late 90s, because of the fall in both unemployment and inflation that we saw in the graph yesterday, there were attempts to argue that both of these actually reduced the natural rate of unemployment, though I never found these arguments fully comprehensible. For example, one idea was that increased international competition made employers less willing to raise prices and wages, and therefore kept wages closer to their market-clearing values. Another was that productivity improvement was increasing the equilibrium real wage, so that increased money wages for other reasons (minimum wage, for example) didn't actually move us as far above equilibrium. As I say, I don't think these stories make as much sense as I'd like. And subsequent experience makes it look somewhat less like the natural rate fell, so we don't need to explain it any more. Apr 10: > I have a question relating to supply shocks. Why do supply shocks, such > as an increase in the price of oil, lead to stagflation (an increase of > both unemployment and inflation)? I thought that, in the long run, > unemployment remains at its natural rate. If the Fed does not carry out > expansionary monetary policy, how does unemployment go back to its > natural rate? Aggregate supply would have to shift back right...but this > wouldn't occur if the public believes the oil shock is permanent... What has to happen after a supply shock is that prices of other inputs, other than oil, must fall relative to oil, and this means especially wages. A rise in oil prices requires a fall in real wages in order for as much labor to be employed as before. This doesn't happen right away, which is why we have the slow process of adjustment that we describe through the SRAS curve. Apr 7: > I'm really sorry for bombarding you with questions. No problem. They are good questions, and I'm glad to have the chance to respond to them. They give me good material for my Q&A page. But in the long run > money market(MD/MS), is the value of money (1/P) the same as the real > interest rate? If not, what is it and it's relation with the short run > money market (where the y-axis is the real interest rate)? No, 1/P is not in any sense an interest rate, real or nominal. We call it the value of money because it tells the amount of goods that money will buy. P itself, of course, is just the usual price level. In the short-run money market, we assume that the amount of money demanded (the amount people want to hold), actually depends on three different things: negatively on the interest rate, r, because r is the cost of holding money instead of bonds; positively on real income, Y, because that reflects the real amount of transactions that people will be using their money for; and positively also on the overall price level, P, because that determines the money value of those transactions. In our diagram, we only show the first of these effects, when we draw the MD curve as a downward sloping function of the interest rate. Since Y and P are not on either axis of the diagram, they can only be brought in as shifts of the MD curve. But we definitely do assume that, for example, a rise in P will increase the demand for money. And note that this is exactly the same thing that we assume in the long- run money market, where a rise in P means a fall in 1/P, and thus, again, a rise in money demand. We are able to focus on 1/P in the long-run model because the assumed constancy of the interest rate means that we don't have to use up an axis of the diagram for it. We could, of course, put P rather than 1/P on the axis and have an upward sloping curve, but Mankiw wanted it to look more like a familiar demand curve, so he used 1/P and called it the value of money. Apr 7: > Is the interest rate fot the money market the real or the nominal interest > rate? It is the nominal interest rate that matters in the short run for money demand, since money demand primarily reflects the choice between holding money and holding bonds, both of which are subject equally to the effects of inflation. Of course, in the short run we also hold the price level and thus the rate of inflation constant, so it doesn't actually matter which interest rate you use. And in the long run our assumption (not necessarily an accurate one, by the way) is that neither interest rate matters for money demand, which simply follows the quantity equation with a fixed velocity. Apr 7: > I'm confused about the effects of an increase in the money supply. > According to the Fisher equation, an increase in inflation (due to an > increase in the money supply) leads to a proportionate increase in the > nominal interest rate. Then why is it that an increase in the money > supply decrease the interest rate in the money market? You are right that the effects of an increase in the money supply are, in a sense, opposite in the short run and in the long run. That's because in the short run both the price level and the expected rate of inflation are fixed, while in the long run they are not. With the price level fixed in the short run, a rise in the money supply can be accommodated by an increase in money demand only if the interest rate falls, since the price level can't be of any help. In the long run, on the other hand, the price level rises by the same amount as the money supply, increasing money demand without any change in the (real) interest rate. But if the monetary expansion is not just an increase in the level of the money supply, but also in its ongoing rate of growth over time, then the price increase is also ongoing, meaning a rise in the rate of inflation. And this causes, through the Fisher equation, the nominal interest rate to rise for a given and constant real interest rate. Note that if we were just to increase the level of the money supply once and for all, then this second effect would not happen. We'd get a fall in the (nominal) interest rate to clear the short-run money market in the short run, and it would move back to its initial level in the long run. The Fisher effect only kicks in if the money supply increases not just once, but year after year, with a new rate of growth and therefore higher rate of inflation. Then, as you say, you will observe first a fall in the nominal rate of interest in the short run, followed eventually by a rise not just to its initial level but above it by the increased rate of inflation. Apr 7: > I am a little confused on whether expected price should increase or > decrease in response to a recession in order to return to long run > equilibrium. > There is recession because expectations are slow to adjust. But there is a > difference between a recession caused by a shift to the left in aggregate > demand (in which price decreases)and a shift to the left in aggregate > supply (in which prices increase). So, should expected price decrease or > increase? They are slow in different directions depending on the cause of > recession (supply or demand side). It's a good question, and I don't have a good answer. This is a weakness of the model. It works fine for a shift in AD, but it doesn't make as much sense as it should for a shift of SRAS due to, say, a cost increase. With a leftward shift of AD, what happens is that the weakened demand causes prices to fall below what is expected, and output falls as a result. Because prices are now below what was expected, over time these expectations are revised downward, the SRAS curve drifts down and the economy moves along the AD curve back to LRAS. With an upward (and therefore leftward) shift of SRAS due to an oil shock, the way we interpret the model literally is that the expected price level rises, so that the SRAS curve intersects LRAS at a higher price. Actual price fails to rise that far, however, so that again actual price is below expected, causing output to fall. Expectations are then again revised downward over time thereafter. That's kind of a peculiar story, I admit, and the reason is that we are using the expected price as our only indicator of cost (wages having been set based on expected prices, for example). What we actually know is that an oil price increase raises cost, and we get the fall in output when the price level rises less than cost has risen. Our story is then that somehow over time cost now falls, and it's a bit hard to see why it should, except perhaps that workers come to accept that their real wages must fall, and they therefore allow their money wages to drift downward. I'm afraid that is the best I can do for an answer. I hope it helps. The bottom-line answer to your first question is that in the model the expected price always falls over time as we recover without any change in policy from a recession, and that is true whether the recession was caused by a shift in AD or a shift in SRAS. But the story (falling money wages) is not very well linked to price expectations. Apr 4: > Hello. I have a question sparked by Thursday's lecture. I understand > why the SRAS slopes up. When AD or SRAS shift right, the SRAS would > increase in the short run. However, intuitively, that doesn't make > sense. Isn't the LRAS a limit, in the sense that it's the most that an > economy can produce given so many resources? In that way, how can SRAS > go beyond the LRAS? Firms may want to produce more because of their > expectations, but I don't understand how they can, given the short run > fixed amount of resources of the country. Using Econ 101 terms, isn't > that like all the firms producing beyond their combined PPF curves? > Could you explain why this works? Good question. The simple answer -- the one most consistent with our models -- is that in long-run equilibrium there is still some unemployment, which we call the natural rate of unemployment. It corresponds to equilibrium in the labor market (given institutions such as the minimum wage, etc.) at which fully informed and flexible workers and firms achieve a stationary level of employment with workers leaving and finding jobs at the same rate. But there are still unemployed workers available in this situation, and if firms can be induced to hire them, output can go up. That's what happens along the SRAS curve: a rise in the price level above the expected price induces firms to hire some of these unemployed workers. Realistically, though it is not included in our model, output can also rise if firms employ their capital more intensively, operating at closer to capacity than they might be comfortable with in the long run. And they can employ the existing workers also more intensively, for longer hours or at a faster pace. Mar 26: > I am writing because I have a question about one of the answers on the > second midterm exam: > > 1. Which of the following is not an effect of inflation being low, as > opposed to high? a. Owners of capital benefit from paying lower capital > gains taxes. b. Workers feel abused when their wages do not rise as > fast as they feel they deserve. c. Consumers spend more time and effort > managing their wealth, trying to keep it in forms that earn interest. > d. Unemployment is increased because firms find it harder to reduce real > wages when market conditions require it. e. For any given real rate of > interest, the nominal interest rate is lower. > > My question is as to why (e) is not also a correct answer (meaning, isn't > (e) also false?). In discussion section, Nalin explained that the > question meant to compare the nominal interest rate with the lower level > of inflation to the nom interest rate with the higher level of inflation. > > However, when I was taking the test, I took the comparison to be between > the real rate of interest with low inflation and the nominal interest > also with low inflation. In other words, I thought the question meant > that with the low inflation, the nominal interest rate will be lower than > the real (example: real rate=5%, nominal=3%). Then, by using the Fisher > Equation: (Nominal Interest Rate) = (Real Interest Rate) + (Rate of > Inflation), I figured that Rate of Inflation is low, but not negative, so > that option (e) is obviously false. > > So, I think that the wording on this question is poor, and it could be > interpreted both the way I took it, and the way the answer does. Because > of this, I think that this question should either be disregarded, or that > those who chose (e) should also gain credit for the question. I see. You thought that (e) said "The nominal rate of interest is lower than the real rate of interest." But it didn't say that. I can't think of any reason for the phrase "For any given real rate of interest," if that had been what we wanted to say. In any case, I still think that answer (c) is better than (e). Mar 26: > i have a question regarding the shift in the SRAS. in lecture u said that > in short run equilibrium will shift to the intersection of AD and the new > SRAS. in the long run, it returns to the LRAS and AD intersect due to > ppls expectations. but in the text book it reurns to the intersect of > LRAS and new AD which it said is due to goverment policies. so how shd > the long run end up as? thanks I'm not sure what you are asking. I think that both I and the book agree that the long-run equilibrium is at the intersection of LRAS and AD. Where is your confusion? Are you wondering about the reason for going there or the reason for the curves being where they are? The reason we go there is, as I said, the adaptations of expectations. The reason for the AD curve being where it is includes all the parameters of behavior and government policies. [Reply Mar 28:] > i am confused with it intersecting with old AD or a new AD(shifted due to > other reasons such as new expectations). Changing expectations of the price level move the SRAS curve, but not the AD curve. If the AD curve moves at first, to start all this, perhaps due to a change in government policy or in private sector behavior such as consumption, then unless you are told that the initial change is reversed, the AD curve will stay thereafter in its new position. The new equilibrium will therefore be at the intersections (of first SRAS and then LRAS) with the new, not the old, AD curve. Mar 25: > I've always heard of the United States requiring China to "Raise the > value of Renminbi (Yuan), saying it's undervalued and severly > contributing to US Trade Deficit ". I've tried to figure out this saying > using Mankiw's Open Economy model. > > 1) Does US mean China has to raise the Nominal Exchange Rate in this case? Yes, that's what they mean. They want the dollar price of the yuan to rise. > 2) If China really raises the value of Yuan, and Price level in the > respective countries remain the same, then the real exchange rate of Yuan > will also rise. What is the mechanism after that ? How can it benefit the > US ? Yes, the expectation is that this would cause the yuan to appreciate in real terms. And that this would make Chinese goods less attractive to U.S. importers, and U.S. goods more attractive, thus increasing our net exports and stimulating our economy. You are quite right that this makes no sense in terms of Mankiw's open economy model, which you'll recall was for the long run only. In the long run, if the yuan appreciates and increases US net exports, then the dollar will also appreciate (relative to other currencies, of course, presumably not relative to the yuan), pushing net exports back to where they need to be to match net foreign investment. But those who advocate this are not interested in the long run. They are looking at the short run, and thus something more like the AD-AS model that we are studying now. In that model, they are hoping that if the appreciation of the yuan increases US net exports, this will constitute an increase in US aggregate demand and cause an increase in US output and employment in the short run. This will only work if the exchange market can accommodate the increase in US net exports, which means we would need an increase in NFI, and it is not clear why that should happen. More likely, if the Chinese buy more from us (or sell us less), the dollar will rise as a result and we'll sell less to others. But the people advocating this don't think about such implications. Mar 25: > I'm writing wondering about question 8 on the exam, which says: > Your father is going through a mid-life crisis and wants to buy a fast > sports car. You are concerned about the impact of his decision on U.S. > GDP. If he buys a Maserati (made in Italy) instead of a Chevy Camaro > (made in the U.S.), then which of the following statements is true? > Answer b provides: Italy's exports and GDP increase; US imports > increase, but US GDP falls. > This seems to me to be correct because my father imports from italy so US > NX decreases (from the rise in imports) and GDP decreases because of > this. Italy's NX goes up from exports, so GDP increases for them. > On the exam answers, it's marked e, none of the above. why is b false? No, answer b is not correct. Imports do not cause GDP to fall. When the father buys the Italian car, this increases consumption and imports by the same amount, leaving GDP unchanged. Mar 22: > I am a little confused with homework#6 question 3d). If Japan bought > machinery from US, it needs to exchange yen for dollars. Then, doesn't US > acquire foreign currency--the yen? So doesn't NFI increase after the > decrease in NFI. Shouldn't going on vacation be a separate part of the > calculation? Yes, you could split this into two events, if you wish. In the first event the US NFI both falls and rises as the Japanese company acquires real capital and the U.S. citizen acquires Japanese currency. In the second event NFI falls and NX falls as the citizen ceases to hold the yen and imports from Japan. Since both events are in the same year, we chose to cancel out the acquisition and then giving up of the yen, but it is not incorrect to mention them. Mar 22: > I have question regarding money. On one of the practice exams it says that > suppose there is an increase in real income and the Fed buys bonds from > the public. What will happen? The answer says that the quantity of money > will increase and the effect on the price level is uncertain. > > The quantity of money will increase because of the bond being bought by > the Fed, but i also thought when money supply increases, there is > inflation sos price level would also increase? What role does the income > play? Real income is Y in the quantity equation MV=PY. So in this problem M and Y both rise, leaving the effect on P ambiguous. Mar 21: > I'm having a hard time finding answers to the last two questions on the > WSJ article, "US Trade Deficit Hits a Record As Exports Sag." It seems > to talk about reasons why exports will continue to drop more than why > they did decrease in January, and more about increasing oil prices than > any quantities. > > If you could point me in the right direction for where to find these > answers, that would be great. I guess you are right that the only explanation given for falling exports is actually about the future, not the past, now that I read it more carefully. I had in mind the reasons given to "broaden the trade deficit going forward" and I missed the words "going forward". Good point. As for the quantity of oil imports, read carefully what it says that the higher oil prices will "offset." Mar 19: > I have been looking at the old exams from previous years, and I have > noticed several questions regarding percent changes in money supply, > inflation, and price level. Most of the time it would give you 2 > variables, and then make you solve for the other variable. There was > also a free response question about it. However, I don't quite remember > doing anything like that in the homework or in class (except PY = MV). > Was this a topic stressed more in previous years, and therefore isn't as > important this year, or should we expect to see similar questions on this > year's exam as well? That sounds like exactly the sort of question that could be asked based on the equation you mention, MV=PY. Maybe this year's GSI's have formulated the questions differently, but I would think you should be able to answer them. Mar 19: > 1) Why doesn't the one-time increase of money supply, (and hence price > level)cause inflation ? > It seems that there are no differences between gradual increase in price > level for 10% for a year and increasing it by 10% in the last day of the > year. It both causes the dollar to worth less, viewed on a year by year > basis. By "inflation" we mean prices (and wage) rising on an ongoing basis, not just to a new level and then stopping. So even if the 10% increase were to be spread over the year, if it did not continue in the subsequent year we might not regard that as inflation. It depends a bit on the context, however, and how you want to define inflation. It is not an unambiguous thing. > 2)The book talks about the domestic investment as an intermediate results > that reacts from the change in real interest rate. > Why isn't it an immediate result? > For example, the books say that local political instability causes the > NFI to shift out (inclining to more foreign investments), and hence the > increase in real interest rate, and hence the decrease in domestic > investment. Why doesn't the political instability cause the people to > lose confidence in the local market in BOTH local portfolio investment > and domestic investment (I) at the very first moment of the capital > flight? It could, yes, although domestic investment is a different kind of thing from what is mostly included in net foreign investment. Most of net foreign investment is acquisition of financial assets, not real ones, and these are perhaps more likely to be appropriated by, or lose their value due to, an unstable government. Also, net foreign investment is explicitly a choice between holding assets in one country or another, so that differences in conditions in the two countries are most likely to influence that choice. Domestic investment, on the other hand, which is acquisition of real capital, is not usually a choice over where to do it, but of whether to do it at all. Thus the domestic investor may not see investing abroad as an option. All that said, you are right that domestic political instability could well discourage domestic investment directly, in addition to affecting NFI. > (3) I am still not very certain about when to move along and when to > shift NFI and NX in the 3-graph model. > Would you mind giving me some hints? If something occurs that would change the level of NFI even if the interest rate did not change, than that shifts the NFI curve. Otherwise it does not shift, and any changes in the level of NFI are solely due to movements along it. Likewise, if something happens that would change the level of net exports (exports and/or imports) if the real exchange rate did not change, then that shifts the NX curve. Otherwise it stays put and any changes in the level of NX are movements along it. Mar 15: > In reply to the answer you gave me about acquring a stack of euros, would > depositing them in a bank that is dominated in US dollars be any > different from depositing in one dominated in euros in terms of NFI? > > My thought process is that it shouldn't matter which currency the bank is > dominated in, as the currency can be exchanged at the exchange market and > the impact should be the same. > > As a result, should acquring a stack of US dollars (exports paid in US > dollars)have the same increase in NFI as acquiring a stack of euros? First, the word is "denominated," not "dominated." And it is the account, not the bank, that is denominated in one currency or the other. Banks may well accept and hold deposits denominated in more than one currency (although our local Ann Arbor banks would never do that). It does make a difference which currency the account is denominated in, because to change that you first have to exchange the money for the other currency. Mar 12: > I am wondering whether just holding/acquiring foreign currency would > increase Net Foreign Investment? Yes, if I, as an American, acquire a stack of euros and hang onto them, that is NFI. > If not, would depositing the currency in a bank increase the NFI? And > does it matter where the bank is located? If I deposit them in a bank where they continue to be denominated as euros, then that is still NFI (though not an addition to NFI if I already had the currency, and was only changing the form of the foreign asset). My understanding is that it doesn't matter where the bank is located, although I suppose if it is a US bank, which then holds the euros for me, it is then the bank that is holding the foreign asset, not me. Mar 12: > 1) In the Mankiw's Open Economy Model, for the 3 graph thing, when NFI > decreases, real interest rate increases to a new level. The equilibrium > for the supply and demand for loanable fund also move to this new level, > but how do we know if SLF moves or DLF moves to attain this new level? or > both of them move together??? I think you are misinterpreting the graphs. The downward-sloping NFI curve means that when the real interest rate increases, then that causes NFI to decrease. That does NOT mean that "when NFI decreases, real interest rate increases," unless some other exogenous change occurred that would cause the real interest rate to increase. Exogenous changes that could do that would include either an increase in (domestic) investment for each level of the interest rate, which would shift the DLF curve to the right, or a decrease in national savings (public and/or private) for each level of the interest rate, which would shift the SLF curve to the left. Of course, NFI could also change due to a change in the desire to engage in NFI itself (again for each level of the interest rate). A reduced desire to buy foreign bonds, for example, would do this. But instead of appearing as a movement along the NFI curve, this would be a leftward shift of BOTH the NFI curve and the DLF curve, resulting in a fall in the real interest rate that would partially offset the effect of the shift itself on the level of NFI. We do not normally have situations in which the SLF and DLF curves both shift at the same time, since that would require two exogenous changes in behavior. Possible, of course, but not what we normally ask about. On the other hand, the LEVELS of both SLF and DLF almost always both change at the same time, as we move along the curves, but whether they move in the same or opposite directions depends on what the outside shock was that caused the change. > 2) When a foreigner buys a US product, it increases NX. > What difference does it make if the guy who collects the money put it > in local bank or foreign bank? How about if he deposits as local/foreign > currencies? If he collects it as foreign money and keeps it as foreign money, then he has acquired a foreign asset and this is a positive change in NFI. And for this purpose it doesn't matter where the bank is that he keeps it in. But usually if he deposits it in a domestic bank, he will first exchange it for domestic currency, in which case he is not acquiring a foreign asset at all. Instead, in this case what matters is what the person who acquires the foreign currency from him does with it. Mar 11: > 1. When country B buys goods from country A, there is an increase in NX in > country A. There should also be an increase in NFI. Does it matter in what > currency country B pays country A in?? Hold on, why do you say that there should be an increase in NFI? In equilibrium the two must be equal, but from what you've said we have no way of knowing whether NFI will rise or NX will end up not changing after all, due perhaps to an appreciation of the currency. But as for your question, whether it matters what currency is used for the transaction, the answer is no. If B pays in its own currency, then the recipient in A will want to exchange it for A's currency. And if B is to pay in A's currency, then it will first have to acquire it by exchanging its own currency for A's currency. Either way, the impact on the exchange market is the same. > 2. When country A buys bonds in country B, NFI in country A increases. > Does the amount of interest country A receives from country B affect > country A's NFI? Again does the currency matter?? No, international interest payments are not included in NFI. They are included instead in NX and regarded as payment for the service of capital. And for the same reason as before, the currency of payment does not matter. > 3. Does a vaction affect NX or NFI or both? e.g. country A's citizens > spending a vaction in country B would mean a decrease in country A's NX > or NFI? What people spend on vacation in another country is considered an import of a service from that country. So it appears in NX. > I'm sorry for so many questions. Thank you for your time and attention. No problem. I wish I was getting more questions, not less. I appreciate your asking. Mar 5: > I was just looking over the articles that were assigned today and > I had a few questions I wanted to ask you. I understand that the two > authors are making contrasting statements; however, I don't understand > the evidence behind the first one by Griswold. How does he say that trade > deficit creates jobs? How does output rise with increasing imports? And > am I correct in assuming that Scott's claim that trade deficit was > hurtful because production in the US went down as the trade deficit grew? Griswold doesn't say, although I can see how you'd get that impression, that the trade deficit creates jobs. What he says is that the trade deficit tends to rise at the same time that employment is expanding, but that doesn't say which causes which. In fact, the causation is the other way around. When the economy is expanding, for whatever reason, that raises income and causes people to import more, increasing the trade deficit. He doesn't spell that out because, just like Scott on the other side of the issue, he has an agenda. You also could be forgiven for thinking that Scott has shown that production and employment actually went down as the deficit grew, but he didn't. He couldn't, because it didn't happen, not in the 90s. What he said was that imports went up, which they did, and that a rise in imports means a loss of jobs. That's not true. It is true that if imports replace production that would otherwise have been done domestically, then that represents jobs that no longer exist. But there is no reason to think, especially in an economy that was expanding like the US in the 90s, that the imports caused production to go down. It didn't. The imports were part of an increase in demand that was happening because incomes here were rising. Mar 2: > Can you give me a clue for problem #9, #10, #11? > Actually, for #9, I got idea about 5%, however about 10%, I have no clue. What is important here is the word "unexpectedly." See p. 256. On question 10, see p. 248. On question 11, you just need to think more about it. Feb 16: > Hi Professor, this is a specific question about the concept of bonds and > present value. Its from homework 4: You get a 2-year government bond > with a 5% coupon rate with a principal amount of $1000. After getting > the first coupon payment after a year, of $50, you sell your bond. It > asks how much you can expect to get for hte "used" bond with prevailing > interest rates of 6% and 4%. What I'm confused about is what happens > when you sell the bond only after getting the first coupon payment. What > happens to the rest of the $1000 you lent? Where in the transaction > between you and the new bond holder does this occur...whats the total > amount you get back? If you sell a bond, then all you get for it is the market price of the bond, whatever that may be. Once you've sold it, you don't own it anymore and are not entitled to anything more. It is the purchaser of the bond who now is entitled to the remaining payments made by the issuer of the bond. In this case, those remaining payments consist of a coupon payment of $50 one year later, plus the principal $1000 at the same time. So the present value, at that time, of $1050 to be paid a year later, is $1050/(1+r), where r is the market interest rate. Notice that if, contrary to what is stated in the problem, the market interest rate were 5% (which is plausibly what the rate was when the bond was first issued), that value would be 1050/1.05=1000, and you'd get back exactly the $1000 face value of the bond. But if the market rate is higher you'll get less, and if it is lower you'll get more. Feb 15: > I am confused with overvalued and undervalued stock and whether to buy or sell. > Is it correct to say that if fundamental is larger than stock price, it is > overvalued and we should sell? > And, if fundamental is smaller than stock price, it is undervalued and we > should buy. No, you've got it backwards. If the fundamentals refer to the present value of the future payments from the stock, and if the fundamentals indicate a higher value than the current market price of the stock, then you'll be buying something that is in some sense worth more than you are paying for it, and that's good. Of course, this is only correct if either you are going to hold the stock long enough to get all those future payments, or if the market price of the stock will move over time toward the value indicated by the fundamentals, so that you'll make money by buying when its price is low. Feb 11: > Hi, I'm in your 102 Macro course. I just thought that I'd point out > something interesting I caught on CNN earlier tonight. Apparently > Gregory Mankiw is taking serious criticism recently for his outspoken > support of "outsourcing"-- shipping American jobs overseas where wages > are considerably lower. A number of those in Congress, including the > House Speaker Dennis Hastert, called for Mankiw's resignation today as > President Bush's chief economic adviser. I just thought it was > interesting that our book's author was in the national spotlight. > > As a side, I'm also curious what your take on "outsourcing" is. Yes, I saw a piece in today's New York Times on this, although I it didn't include the demand for his resignation. It is indeed interesting, and also very sad, since what Mankiw said was exactly right in my opinion. Outsourcing is just an example of the economy responding properly to the differences in relative costs in different countries and industries, the result of which is to raise average incomes here and abroad. Like all increases in trade, it requires adjustments that mean loss of jobs in some industries and creation of jobs in others, and this is painful for those in the former. But while this may be a good reason to have policies to assist these people (such as unemployment compensation), it is not a reason to deny society the overall gains that these adjustments make possible. It will be very sad if Mankiw is forced out of his job for stating the truth. Feb 9: > I have a question on Homework #4 problem 5 > For part A do we just need to find the present value of the price listed? No, what you should be willing to pay for the stock depends on both the dividend payment that you'll get just before you sell it, and the price that you'll get when you sell it. > What does the dividend payment have to do exactally with the price of a > stock? That is not important for this question, for which you are asked what you should be willing to pay for it given the dividend and various prices of the stock. But in general, one expects prices of stock to be positively related to expected dividends, other things equal, since dividends are the payments that owners of the stock receive from the firm. Can I ignore the inflation rate and put everything in terms of the > real interest rate which is given? No, both the dividend and the future price are nominal amounts, so you need to use the nominal interest rate to value them. Feb 7: > I have some problems with the concept of inventories. Are inventories > something desirable? What is their relationship with investment, if any? Inventories are amounts of goods that firms have on hand, either waiting to be used as inputs or waiting to be sold. Are they desirable? I'm not sure that you could say that they are either desirable or undesirable, really. They are necessary, since without them firms would not have the inputs when they need them to produce, or would not be able to give their customers what they want when they want it. But otherwise, goods in inventory are not doing much good, are taking up space, and are tying up the money that was used to pay for them. So if it is possible to get by with smaller inventories, then that is desirable, as long as it doesn't mean that you run out. New technologies that have permitted firms to hold smaller inventories have therefore helped to increase productivity. An increase in inventories is defined as (a part of) investment, and a decrease in inventories contributes negatively to investment. In general, though, a rise in inventories may or may not be intentional on the part of the firms that hold them. Feb 3: > On question 6 of the homework, what is the formula to figure this out? > I've tried a couple different things and haven't been able to get it. Starting with zero wealth in 1980, each year their new wealth becomes equal to their old wealth plus their savings. Their savings is the stated fraction of their total income. Their total income is 40,000 plus the interest on (8% of) their previous period's wealth. Turn these sentences into equations and then repeat them for each of the 35 years. (That's why you'll want to use a spreadsheet.) Jan 27: > I have a few questions about "The Historical Lessons of Lower Tax > Rates." > 1. What is a marginal tax rate? The marginal tax rate is the amount you pay in income taxes out of an additional dollar of income. The tax schedule may be (and in the U.S. is) set up so that you pay higher marginal tax rates on higher incomes. For example, it might require you to pay no tax on the first $10,000 of income, pay 10% of the next $40,000 of income, pay 20% of the next $50,000, and pay 30% of the rest. In that case, a person with income of, say, $30,000 would have a marginal tax rate of 10%, even though they pay a total tax of $2000 and therefore their average tax rate is 2000/30000= 6.7%. Similarly, a person with income of $200,000 has a marginal tax rate of 30%, but their total tax is (if I've worked this out correctly) 4,000+10,000+30,000=44,000, which is 22% of their income. In general, with a tax schedule that levies a higher marginal tax rate on higher incomes, everybody has an average tax that is lower than their marginal tax rate. > 2. What do the numbers signify when the author writes things like, > "Kenneday proposed across the board tax rate reductions that reduced the > top tax rate from more than 90 percent down to 70 percent?" Because I > know that taxes were not 90% of income. Right, but the marginal tax rates WERE this high. Again, these were marginal tax rates, not average ones, so it was not the case that anyone paid over 90% of their total income in taxes. But it was the case that people with very high incomes, if they were to increase those incomes even further, would pay over 90% of the increase to the government. The highest marginal tax rates in the U.S. today (under the Federal income tax) are now down below 40%, I think. But they are still quite a bit higher than that in some of the countries of Europe. As I recall, when marginal tax rates were over 90% here in the U.S., they were over 100% in some countries of Europe. Jan 21: > My question is about hw2 problem 7 in which we are to find the ratio > of EU per capita and that particular country, how do you do it? To calculate the ratio of x to y, you divide x by y. > Then secondly how do you find how fast that ratio grows. thank you for help. It tells you in the problem how to find the growth rate of a fraction. A ratio is a fraction. Jan 9: > Just wanted to let you know that I'm watching Inside Politics on CNN > right now and they just finished interviewing the economist who wrote our > Econ 102 textbook, Dr. Mankiw. He was talking about the unemployment > rate for December, the number of people who have stopped looking for > jobs, and Bush's ability to understand the economy (in response to Paul > O'Neill's quote that President Bush "was like a blind man in a roomful of > deaf people" during cabinet meetings). He also discussed his positive > outlook for 2004, even though only 1,000 new jobs were created last month > instead of the 130,000 that were predicted. It was interesting to hear > him talk about these current economic issues, particularly since we have > been reading his book. It would have been nice to hear him talk more > about the economy and less about defending the President, however, but > I'm sure that comes with his job. Interesting. I'm sure he gets on TV a lot, in that job, but I haven't seem him there. Thanks for telling me.