QUIZ 1: Macro – Winter 2008

Name: ______________________

Section Registered (circle one) T/Th 8:30-10:00 T/Th 10:00-11:30 T 6:00-9:00

Question 1

Put answers in the space provided. Calculators are allowed. Answers will be graded on a partial credit scale. Perfect answers with the appropriate documentation of your work will be given the complete score; answers with an intuitive attempt at the correct procedure but a wrong answer will be given 50% credit; answers with a totally incorrect procedure (even if the answer is correct) will be given either 0 or 1 point. This implies that you must show your work to get full credit!!!!

Suppose you were given the following data about average hourly wages of all private U.S. employees for the following years. All wages are reported in current year dollars (i.e., 2003 wages are in 2003 dollars, etc.). I also listed the corresponding CPI for those years. These data are actual U.S. wage and CPI data. I picked data from June of each year so the CPI and wage data will correspond to the same time period. The current base year of the CPI is 1982 (CPI in 1982 = 100).

Nominal Hourly Wage Measured CPI Level2003 $15.37 183.42004 $15.67 189.32005 $16.08 194.02006 $16.73 202.42007 $17.40 207.8

a) In 2003 dollars, what was the real wage in the U.S. in 2007? Use the CPI data to convert the 2007 nominal wage into the 2007 real wage (expressed in 2003 dollars). (4 points)

This was right from the supplemental notes:

2007 Real Wage (in 2003 dollars) = 2007 Nominal Wage (in $2007) * CPI(2003)/CPI(2007)

= 17.40 * 183.4/207.8 = $15.36

b) There is a growing body of evidence that finds that the CPI inflation rate is overstated by 1 percentage point per year (even with the innovations they have made in measurement during the last 15 years). Take as given that the CPI inflation rate overstates the true inflation rate by 1 percentage point per year. Assuming that the 2003 CPI level is measured correctly, what should be the “true” level of the CPI for the U.S. in 2007? (In other words, assume that the 2003 CPI is measured correctly. Adjust the 2007 CPI for the inherent measurement error). Use the exact formula. (4 points)

This was slightly harder than part (a) – but not by much.

We are assuming the 2003 CPI level is measured correctly. The inflation rate is biased by 1% per year (that means the 2003-2004 inflation rate, the 2004-2005 inflation rate, the 2005-2006 inflation rate and the 2006-2007 inflation rate are all biased upwards by 1%).

Mathematically, that implies that the 2007 CPI is biased upwards by (1.01)4 (1 percent for four inflation cycles).

In other words, the CPI in 2007 (true level adjusted for measurement error) = CPI in 2007 (reported)/(1.01)4

CPI 2007 (true level) = 199.69

(some people took the mis-measurement to have occurred over 5 years – this is not correct – but, I gave 3 out of 4 points for people who did this – so, if you provided an answer of 197.71 (which is 207.8/(1.01)5) you received 3 out of 4 points).

c) Using the “true” level of the CPI for 2007 (which you computed in part b), solve for the “true” growth rate in real wages in the U.S. between 2003 and 2007 (i.e., what is the real growth rate in wages once you adjust for the measurement error in the CPI inflation rate). Use the exact formula. Your answer should be presented as a five-year growth rate (i.e., your answer should be something like xx.xx%). (4 points)

Given your answer to part b, this should be easy. Real Wages in 2007 measured in 2003 prices (adjusting for mismeasurement) = 17.40 * (183.4/199.69) = $15.98.

Notice, the wages are much higher than in real terms than computed in part a). This makes sense since I told you that the price index was mismeasured upwards.

How do you compute the real growth in wages between 2003 and 2007?

(Real wages 2007 – Real Wages 2003)/Real Wages 2003 = (15.98 – 15.37)/15.37 = 3.97%

This is how I asked you to compute the real wages (if we all compute it the same way, it makes it easier for my grader to grade).

Given that, many of you computed the real wage growth in alternate ways.

First, some of you computed the ANNUALIZED change in the real wage (instead of 3.97 growth rate over the five years, you computed an annualized growth rate of (1.0397)1./4 – 1 = 0.98% per year. Even thought this was against the directions, I gave full credit for this answer.

Second, some of you used the approximation formula:

Percentage change in nominal wages – inflation rate = percentage change in real wages

13.21%-8.88% = 4.33% - if you gave the approximation formula, I gave you 3 out of 4 points.

Lastly, conditional on making a mistake in part b, we did not penalize you if you carried through that mistake to part c. The only caveat of that is that we had to follow your work to see the carry through mistake. If you did not show your work clearly (as I forcefully instructed in the instructions at the beginning of question 1), that is your fault. As a result, we will penalize for carry through mistakes if we cannot follow your work. (Remember, my grader is doing the grading – it is not his job to guess whether you know what is going on or not – so, if you did not show work, points will be deducted).

Question 2

In this question, circle all of the true statements to the following question stem. Note: There may be multiple true answers or there may be no true answers. You should view this as a series of true/false questions where you are suppose to circle all of the statements that are true (given the question stem). (4 points total – one point each).

According to the material we have covered in class so far, which of the following are true?

a. In macroeconomic equilibrium, aggregate income is equal to the sum of consumption, investment, government spending, and net exports.

True. This was easy. Y = expenditure = income = production. Aggregate expenditure = C + I + G+NX. So, it is true that income, in equilibrium, will equal aggregate expenditure.

b. Recessions are always accompanied by falling inflation rates.

False. As we saw in class, supply side recessions (from the aggregate supply curve moving around) cause recessions and rising price pressures (inflation).

c. The growth rate in real GDP (over a given period) will always exceed the growth rate in nominal GDP (over the same period) if the inflation rate over that period is negative.

True. This is just math. Real GDP growth = Nominal GDP growth – inflation rate. The only way that Real GDP growth can exceed nominal GDP growth is if the inflation rate is negative.

d. Starting in the early 1980s, GDP volatility declined dramatically in the United States relative to the previous five decades.

True. This is just a fact from class. See the lecture notes.

Question 3

In “Big Questions and Big Numbers” (Economist 7/15/2006), the article describes a large “device” developed by William Phillips (an economist from LSE) that is on display in London’s Science Museum. What was the purpose of the devise developed by Phillips? Your answer should be brief (no more than 7 words or so) – I am just trying to get a sense of who read the articles and retrained some basic information. (4 points)

There were many answers to this question that were acceptable including: model of the economy, circular flow of income and expenditure, system of pipes to model economy, … We gave credit for all plausible answers (even if some of you wrote more than seven words – in the future, I will be much stricter on the word limit – it imposes an unfair burden on the grader when people give 4 sentence answers to something that can be answered in less than 7 words).