Econ 162B Fall 2011 Kenny Christianson due November 4 ANSWER KEY PROBLEM SET NUMBER SEVEN 1 The Chinese government is able to keep the value of the yuan artificially low in the following way First an increase in the U S demand for Chinese products will increase the demand for yuan in the United States and the supply of dollars in China Without any further action the dollar would depreciate and the yuan would appreciate The Chinese counter this by purchasing U S Treasury securities If there is an increase in the Chinese demand for US Treasury securities then in China the demand for dollars will increase As Chinese investors exchange their yuan for dollars the supply of yuan in the United States will also increase In China the increase in the demand for dollars will cause an increase in the value of the dollar The dollar appreciates In the United States an increase in the supply of yuan will cause a decrease in the value of the yuan The yuan depreciates These actions can counter the original effects of the increase in demand so the value of each currency remains constant Graphically Market for yuan in the United States Market for dollars in China E Syuan 1 E S E E 1 E Syuan S D yuan Dyuan D 1 E D yuan yuan yuan where E price of yuan in dollars yuan and 1 E price of dollars in yuan yuan When there is an increase in the Chinese demand for US Treasury securities the demand for dollars in China will increase As demand increases the value of the dollar 1 E increases and the quantity of dollars exchanged will also increase The increase in the demand for dollars in China is equivalent to an increase in the supply of yuan in the United States as Chinese investors exchange their yuan for dollars The value of the yuan E declines and the quantity of yuan exchanged increases to match the increase in dollars in China The net effect is that the value of each currency remains the same Econ 162B A0 A1 Fall 2011 Answer Key 7 2 In sum an increase in the Chinese demand for US Treasury securities will cause the yuan to depreciate and the dollar to appreciate By keeping the price of yuan artificially low in this way the Chinese government is able to encourage the sales of its exports to the rest of the world 2 The individuals of Cuomoville can be categorized in the following way Employed Yvette Xavier Wanda Robert Patricia Ophelia Unemployed Samantha Quncy Not in Labor Force Zach Victor Ursula Thomas Out of the population of Cuomoville the labor force consists of those who are employed and unemployed or 8 individuals Of those 2 8 are unemployed for an unemployment rate of 25 3 Debtors are harmed by unanticipated deflation because the purchasing power of their debt payments will be increasing over time With deflation the average level of prices falls so the value or domestic purchasing power of money increases For borrowers the fixed nominal loan payments that must be made will represent greater and greater sacrifices of real goods and services as prices decline As prices of goods and services fall the income earned by the suppliers of these goods and services also declines So borrowers will find it more and more difficult to meet their nominal loan obligations In this way unanticipated deflation harms borrowers Similarly unanticipated inflation benefits borrowers and other debtors since the purchasing power of their debt payments will be declining over time In sum with unanticipated inflation the real burden of nominal debts declines benefiting borrowers and harming lenders With unanticipated deflation the real burden of nominal debts increases so lenders benefit and borrowers are harmed 4 a Archie faces cyclical unemployment because he was laid off due to a lack of orders which occurs during a downturn in the business cycle b Barbara faces frictional unemployment because she is searching for her first real job c Carl faces structural unemployment because he lost his job due to technological change d Debbie faces seasonal unemployment because she is unemployed during the winter but not in other seasons e Eric faces structural unemployment because he lost his job due to technological change f Frederica faces frictional unemployment because she is between jobs 5 To answer the questions it is easier to construct the following table Econ 162B A0 A1 Fall 2011 Answer Key 7 3 Halloween Party Price Index item 36 oz bag of candy bars gallon of apple cider one half keg of beer Teenage Mutant Ninja Turtles costumes 16 oz plastic cups 13 oz bag Tostitos 24 oz jar salsa pumpkins candles total quantity price in 2010 price in 2011 cost in 2010 cost in 2011 100 4 2 1 4 6 2 4 4 2 00 2 50 90 00 14 00 0 03 3 00 4 00 2 00 1 00 4 75 3 00 100 00 18 00 0 05 4 00 3 00 2 50 2 00 8 00 5 00 90 00 56 00 3 00 18 00 8 00 8 00 4 00 19 00 6 00 100 00 72 00 5 00 24 00 6 00 10 00 8 00 200 00 250 00 a In 2010 the cost of a Halloween party was 200 b In 2011 the cost of a Halloween party was 250 c To construct a price index Price index cost of market basket in current year x 100 cost of market basket in base year So for the Halloween Party Price Index HPPI for year 1 base year HPPI1 200 200 x 100 100 In the base year a price index always equals 100 d for year 2 HPPI2 250 200 x 100 125 e the rate of inflation is always the percent change in the price index So Inflation rate 125 100 100 x 100 25 6 In the classical model it is assumed that markets always clear In the labor market real wages are flexible enough so that the market is always in equilibrium If the quantity of labor demanded is always equal to the quantity of labor supplied then there is no involuntary unemployment In this model anyone looking for a job is able to find one Keynes on the other hand recognized that wages may be sticky so that involuntary unemployment may result If wages cannot fall to their equilibrium a surplus in the labor market or involuntary unemployment may result In the classical model a decrease in labor demand will not result in unemployment Wages will fall to bring the market back to equilibrium In the Keynesian model a decrease in labor demand may increase unemployment if wages are inflexible even if the labor market starts in equilibrium If wages do not fall to the new equilibrium then a surplus of labor involuntary unemployment will result Graphically Econ 162B A0 A1 Fall 2011 Answer Key 7 4 no involuntary unemployment W W involuntary unemployment SL W SL W W DL DL L L Ld L Ls L CLASSICAL KEYNESIAN no involuntary W unemployment W …