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Spring 2016
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Economics 304
Homework #1 – A ride into reality!
Due Friday 9/9/16, at the beginning of class - no late papers accepted!
Instructions: Please show all work or points will be taken off. Good luck!
1. (45 points total) In this first homework assignment, we are getting our ‘hands dirty’ to
get familiar with some of the major macroeconomic variables that we will be using and
working with throughout the semester. Our first chapter with ‘something to sink our teeth
into’ is chapter 3 in the packet and it is all about the factors of production, the labor
market, and of course, the production function. Major variables in this part of the
macroeconomy (i.e., the supply side of the economy) include, but certainly are not
limited to, employment (denoted N), real wages (denoted w = W/P where W = nominal
wage and P is the price index - typically the CPI or the PCE index) and real GDP
(denoted Y). When we move to the demand side of the economy we encounter many
more major macroeconomic variables including consumption (C), investment (I), and the
real interest rate (denoted r), among others. We are going to use FRED as our source of
data (many professional economists use this site, nice clean data!)1
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FRED stands for Federal Reserve Economic Data.- click Here for the FRED website
YOU MUST SHOW ALL WORK, IF YOU SIMPLY PUT THE ANSWER DOWN
YOU GET ZERO POINTS - I know for a fact that many students copy each others
homework!
Use the following link to answer part a) below
Click Here for data on the MW
PLEASE USE THE MW TABLE TO ANSWER PARTS a and b
a) (5 points) What is the rate of inflation between 1976 and 1977? What would the
nominal minimum wage have to be in 1977 to equal the real purchasing power of the
minimum wage in 1976?
76 2.30/X = 6.34 X = .368
77 2.30/X = 5.95 X = .387
%ΔX = Π = 6.61%
2.30/.363 = X/.387............ 2.45
Click Here for the latest report on PCE inflation
Click Here for oil prices (West Texas Crude)
We have talking about inflation and how it has been too low.
b) (5 points) The Fed targets the overall PCE rate of inflation as opposed to the core rate
of inflation --- given the latest PCE report, we notice that the core rate of PCE inflation is
higher than the over PCE rate of inflation. What is the difference between the core and
overall rate of PCE inflation, what are the latest numbers and why is the overall rate of
inflation lower than the core rate of inflation? Click Here for some help. (use the Percent
change from month one year ago).
CORE EXCLUDES FOOD AND ENERGY SO IF FOOD AND ENERGY PRICES
ARE RISING LESS OR ARE FALLING, RELATIVE TO THE REST OF THE
ITEMS, THE OVER ALL WILL BE LOWER THAN CORE, AS IT IS NOW
OVERALL = .8%. CORE = 1.6%
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c) (5 points) Using the link for West Texas Crude oil prices, what is the percent change in
oil prices from 7/15 - 7/16 and is your answer consistent with your answer in part b)
above?
-12.28%....YES!
Use the article on the cost of living in PA to answer parts d) and e)
d) (5 points) Assuming that Centre county is the base county, what is the price index in
Forest county? In Chester county?
FOREST = 82.61 CHESTER 146.64
e) (5 points) Assume that you received a job offer in Centre county for $65,000. What
offer would you need to receive in 1) Forest county and 2) Chester county to achieve the
same purchasing power as $65,000 in Centre county.
FOREST $53,695.5
CHESTER $95,316
f) (5 points) My sister started teaching in September of 1972 with a salary of $7,000.
Using the CPI price index, (Click Here for the CPI) what would she have to make in
salary in July of 2016 to have the same real purchasing power as $7,000 did in September
of 1972?
7,000/.421 = X/2.39825......X = $39,876.37
Use the following links to answer the following questions:
For Nominal Wages (W)
Price index CPI (P) 2
Employment (N)
Click Here
Click Here
Click Here
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Hint, when deflating using a price index, move the decimal two places to the left. For example, in 12/09
W = $18.84 and the price index was 217.347. The real wage is thus 18.84 divided by 2.17347 = 8.67
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g) (15 points) My guess is that most of the class is somewhere around 20 years old. In the
space below (please make space by hitting enter), draw a diagram with the real wage
denoted (w) on the vertical axis and employment on the horizontal axis. Use link for
employment data.
Plot two points on this diagram - point A that represents the real wage and employment in
September 1996 and then plot point B as the real wage and employment for July of 2016.
Your graph should have two points and no lines. What is the percent change in the real
wage during this period and how many more people are employed since you were born
(approximately) ? Please make sure you completely label graph.
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2. Use the following two links to answer the following questions:
For Nominal Wages (W)
Click Here
Price index CPI (P) Click Here
What we are going to do in this problem is to rate 4 different Presidents in terms of what
happened to the real wage and inflation during their terms.
YOU DON'T HAVE TO PRINT OUT PIC IF YOU WANT TO SAVE INK!
The dates of the terms are below:
Reagan:
Clinton:
Bush GW
Obama
1/1981 - 12/1988
1/1993 - 12/2000
1/2001 - 12/2008
1/2009 - present
Please show all work throughout this assignment!
a) (5 points) Calculate the real wage at the beginning of the Reagan administration and at
the end of the Reagan administration and calculate the % change in the real wage during
his term.
-3.64%
b) (5 points) Calculate the real wage at the beginning of the Clinton administration and at
the end of the Clinton administration and calculate the % change in the real wage during
his term.
6.93%
c) (5 points) Calculate the real wage at the beginning of the Bush GW administration and
at the end of the Bush GW administration and calculate the % change in the real wage
during his term.
6.76%
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d) (5 points) Calculate the real wage at the beginning of the Obama administration and at
the end of the Obama administration and calculate the % change in the real wage during
his term.
3.80%
e) (5 points) Please rank each President in terms of the performance of the real wage
during their terms showing the percent change in the real wage for each President.
CLINTON... BUSH GW.... OBAMA...... REAGAN
f) (15 points) We have been talking about the fact that inflation is too low for the most
part across the globe. This certainly has not been the norm......years ago it was customary,
perhaps, to 'worry' more about inflation being too high. In the space below calculate the
percent change in prices during each of the 4 Presidential terms and divide by the number
of years served (8 for Reagan, Clinton, Bush GW and 7 for Obama). This will give us a
rough measure of the average annual inflation rate for each President - rank them from
the highest 'inflation' President to the lowest 'inflation' President. Are your results
consistent with the concept of dis-inflation - a term that refers to inflation falling through
time (prices are still rising but at a lower rate)? As always, show all work.
REAGAN 4.8% ...CLINTON 2.78% ...BUSH GW...2.55% ....OBAMA..1.88%
YES, CONSISTENT WITH DIS-INFLATION
3. (40 points) In this problem we are going to examine what it means for monetary policy
if the natural real rate of interest (r*) is 1% instead of the assumed 2% that it has been for
years. Noting that the target for inflation is 2%, please answer the following questions:
Use the link below to answer a) and b). For other questions, use the article "When 2% is
not enough" . This article is posted on HW page.
http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm#18545
a) (5 points) Go to the June 19 -20, 2012 meeting information to the projection materials and
click on 'Accessible Figures' and go to Overview of FOMC participants' assessments of
appropriate monetary policy and calculate the average longer run target for the federal funds rate
(please show all work).
ADD THEM ALL UP, DIVIDE BY 19 = 4.11%
b) (5 points) Go to the June 14 -15, 2016 meeting information to the projection materials and
click on HTML and go to ‘Figure 2. FOMC participants' assessments of appropriate monetary
policy: and calculate the average longer run target for the federal funds rate (please show all
work).
3.14%
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c) (5 points) Using your answer from a) and assuming the target for inflation is at 2%,
what is the ‘natural’ or ‘neutral’ real rate of interest.
2.11%
d) (5 points) Using your answer from b) and assuming the target for inflation is at 2%,
what is the ‘natural’ or ‘neutral’ real rate of interest.
1.14%
e) (5 points) According to the article: "When 2% is not enough" what explains the
difference between your answers in part c) and part d)?
HIGHER SAVINGS - WE ARE GETTING OLDER - EXPECTED INCOME
FALLING, SAVE MORE FOR RETIREMENT - WE ARE CONSUMPTION
SMOOTHERS!
LESS ATTRACTIVE INVESTMENT OPPORTUNITIES IN A LOW GROWTH
ENVIRONMENT
f) (5 points) If we assume that the Fed’s lower bound for the federal funds rate is indeed
zero, what is the maximum they lower the federal funds rate given your answer in part a)
….. how much can they lower the federal funds rate given your answer in part b)
a) 4.11%
b) 3.14%
g) (5 points) Some say that your second answer in part f) is unfortunate if we get into
another recession? Why? Given the last three recessions, what is the average amount that
the Fed lowered the federal funds rate to fight the recession? - use the information in the
article from the economist: ‘When 2% is Not Enough.’ Please show all work.
5.79%
h) (5 points) Now let’s move on to the gist of the article. Why would bumping up the
inflation target to 4% satisfy some of the critics (the economist) who say that an inflation
target of 2% is not enough. To answer this question, please assume that the natural real
rate of interest is as it is from your answer in part d). What is the neutral long run federal
funds rate now and if we do hit another recession, assuming a zero lower bound, how
much could the fed lower the federal funds rate now?
1.14% = i - 4%...i = 5.14% - they can lower it by 5.14% ..the Fed has more bullets!
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