New: ECO 204 Homework 2 (40 points)
1. Unemployment: (15 points)
Part I: Country A – Labor Force Participation
A country, Country A, has a civilian population of 300 million. Of these:
- 80 million are under 16 years old or in institutions (e.g., prisons, long-term care facilities)
- 48 million adults do not want to work and are not looking for a job
- 160 million people are employed
- 12 million people are unemployed and actively seeking work
Answer the following:
(a) How many people are not in the labor force in Country A? (3 points)
(b) What is the size of the labor force in Country A? (3 points)
Part II: Country B – Unemployment Types and Rates
A different country, Country B, has the following labor market data:
- Labor force: 200 million
- Unemployed: 14 million
- Frictionally unemployed: 3 million
- Structurally unemployed: 5 million
Answer the following:
(c) What is the actual (total) unemployment rate in Country B? (2 points)
(d) What is the natural rate of unemployment in Country B? (2 points)
(e) What is the cyclical unemployment rate in Country B? (3 points)
f) What might the unemployment data suggest about the overall state of the economy in Country B? Explain briefly. (2 point)
2. Suppose you borrow $3,400 at 10% annual interest to buy gold, which you expect to be worth $4,000 in two years. Should you make this investment? Justify your answer using either a present value or a future value calculation. (3 points each)
3. Individual A spends $3,000 on consumption when her income is $0, and $10,000 when her income is $8,000.
Individual B spends $4,000 on consumption when his income is $0, and $15,000 when his income is $12,000. (9 points)
a. Write the consumption function for individual A and B.
b. Interpret the meaning of individual A’s marginal propensity to consume, and individual B’s marginal propensity to save.
c. If most households behaved like A versus B, how would the overall multiplier differ, and what would this imply for the effectiveness of a fiscal stimulus?
4. Answer all questions below:
I. What is a recessionary gap, and what condition(s) in the economy can lead to one? (3 points)
II. In your own words, explain what the marginal propensity to consume (MPC) is. How is it calculated? Provide a numerical example. (3 points)
III. Suppose the recessionary gap is $5,250,000 and the marginal propensity to consume (MPC) is 0.85. How much should autonomous spending increase to close the gap?
(3 points)
V. An economy has an income multiplier of 15. Explain what this implies about the effect of a $200 million increase in spending on total income, and note one real-world factor that might prevent the full effect from occurring. (4 points)