← 1. The Macro Lens

Exercises

Problems to check your understanding of this chapter. The solutions are folded away — try them yourself first.

Easy

1EasyCompute

A small economy has consumption C=250C = 250, investment I=100I = 100, government spending G=90G = 90, and net exports NX=−40NX = -40.

Find GDP and the consumption share.

A 400400 GDP economy — consumption takes 62.5%62.5\%.
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  1. GDP is the sum of spending: 250+100+90−40=400250 + 100 + 90 - 40 = 400.

  2. The consumption share is 250/400=0.625250 / 400 = 0.625, that is 62.5%62.5\%. Even with negative net exports, consumption still fills most of the circle.

Answer

GDP=400GDP = 400

Medium

2Medium

A demand shock sets the output gap to −5%-5\%.

(1) In the Keynesian world, what is the gap after 1010 periods?

(2) In the New Keynesian world, what are the gap and the price level (starting at 100100) after 33 periods?

Shock 55, New Keynesian — the gap shrinking by a factor of 0.60.6 each period.
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  1. (1) Keynes treats prices as frozen (λ=0\lambda = 0). The gap is gt=−5⋅(1−0)t=−5g_t = -5 \cdot (1 - 0)^t = -5 — after 1010 periods it is exactly where it started.

  2. (2) In the New Keynesian world the gap shrinks to 0.60.6 of itself each period: g3=−5⋅0.63=−5⋅0.216=−1.08%g_3 = -5 \cdot 0.6^3 = -5 \cdot 0.216 = -1.08\%.

    Meanwhile prices fall by 5⋅(1−0.216)=3.925 \cdot (1 - 0.216) = 3.92, leaving the price level at 100−3.92=96.08100 - 3.92 = 96.08.

    The remaining gap, 1.081.08, plus what prices absorbed, 3.923.92, adds back up to exactly the shock, 55.