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Economics 321

Homework 1

1. The standard Keynesian model imposes an aggregation structure over decision makers and commodities for an economy.

(a) Describe the standard aggregation structure for a Keynesian model. Specifically, what markets are assumed to exist and which decision-making units participate in each market?

(b) Define Walras' Identity and explain how the identity imposes an aggregate consistency condition on a model of a market economy. What is the implication of Walras' Law with regard to solving for an equilibrium in the standard Keynesian model? Carefully explain.

2. Define the term gross domestic product (GDP) and explain how this aggregate differs from gross national product (GNP). What is the distinction between nominal and real GDP (GDP and RGDP)?

The table below presents GDP numbers for the years 1990-97 and GDP price index numbers for the same years.

Nominal  GDP            GDP  Price  Index

1990            5,803                          86.83

1991            5,986                          89.76

1992            6,319                          91.70

1993            6,642                          94.16

1994            7,054                          96.14

1995            7,400                          98.19

1996            7,813                          100.00

1997            8,301                         101.66

Compute RGDP numbers for each of these years using 1996 as the base period. Did a real-output contraction occur during any of these years? Carefully explain.

3. The uses-of-saving identity (Spvt = I + [-Sgovt] + CA) states that an economy's private saving is used in three ways: to finance investment, the government budget deficit, and the current account imbalance. First, using this identity, carefully explain the implications of a larger government budget deficit. Second, assuming a small open economy with Spvt and I fixed, what the implication of a larger government budget deficit?

4. Consider an environmental regulation that requires businesses to make current investments that reduce the amount of harmful emissions. Assuming the future return on these investments is a cleaner environment, how will this policy affect the measure of current and future real GDP? Would GDP be al useful index to measure whether people's lives have improved? Carefully explain.