Macroeconomics

Chapter 3

Question 1: I couldn't understand how to compute the optimal number of baker hired?

My answer: To get the number of bakers, any firm should hire bakers that makes MPL=w/p. For example when the MPL=w/p=8, at this level and from table 1.1 you find that the appropriate number of bakers should be 4.

Chapter 4

Question 1: How purchasing power is transferred from lenders to borrowers and vice versa? I couldn't understand how it works for expected inflation and actual inflation?

My answer: Actually many contracts we make in our daily life are based on expected inflation. Everyone of us feels everyday the hardship of inflation and therefore must make expectation about it. A worker, for example, when negotiating with his boss about a wage increase for the next year, should bear in mind how important the cost of living will be for coming year. So he/she should make expectations about the rate of inflation.

Sometimes, our expectations happens to be wrong and in this case, one party of the contract will lose, while the other party will gain. Let's take the classical example of a borrower (a firm) and a lender (a bank).

at t=0, the two parties agreed for a credit contract of 1,000 dinars, that must be paid the next year, t=1. The nominal interest rate is 5% and the bank expects an inflation rate of 2 % next year.

* If the next year (actual) inflation rate is 2 %...then the bank realizes the profit (real interest rate, r) that she expected a year before which is r=3% (r = 5 - 2). In this case there is no transfer of the purchasing power.

*If the next year's actual inflation rate happens to be more than expected and it is 3%...Then the bank makes less profit than she expected, r= 2% (r= 5 - 3) and the firm pays less than she expected to pay, r=2% (2% < 3%). In this case we say there is a transfer of the purchasing power from the bank to the firm.

*If the next year's actual rate of inflation happens to be less than expected, 1%, then in this case the bank will make more profit than she expected, r=4% (r=5 - 1) but the firm will pay more than she expected to pay, 4% (4% > 3%). In this case we say that there is a transfer of the purchasing power from the firm to the bank.

Chapter 6

Question 1:

In chapter 6 (unemployment) (slide 31): what do we mean exactly by "Yet, most of the total time spent unemployed is attributable to the long-term unemployed." ?

My answer: The second column in the table (slide 31) shows the percentage of all unemployed workers whose spell (period) lasted the number of weeks shown.

The number in the third column is a ratio. The denominator is the total number of weeks spent unemployed, obtained by multiplying the total number of unemployed persons by the number of weeks of the average spell (period) of unemployment.

The numerator is, for each category, the number of people in that category times the duration of the average spell of unemployment for that category.

Thus, the number in this column is the share of total time spent unemployed attributed to workers in that category.

==> So, the second column tells us the percentage of unemployed people per time category and the third column tells us the share of each category (time category) in the total number of unemployed days.

According to the table, most unemployed people stay unemployed for a short period, but the number of unemployed days of the category, Long-Term (>15 weeks) is very important.

Chapter 10

Question 1: What is the difference between short run and long run and what's the IS and the LM curves?

My answer:

1. Short run and Long run: Actually, the economy behaves DIFFERENTLY depending on whether we try to understand its behavior in the long run or the in the short run. For example, some theories about the economy in the LR do not apply in the SR..that is why we need other theories to understand the working of the economy in the short period. The two last chapters (9 and 10), unlike the previous ones, try to give us some theories of the behavior of the economy in the SR.

2. The IS-LM model is an important component in defining the Aggregate Supply and demand model that explains us the behavior of the economy in the short run.(see slide 41 in chapter 10).

The IS model tells us the combinations of (r, Y) that result from equilibria in the market for goods and services. the LM model tells us the the combinations of (r, Y) that result from equilibria in the market of money.