INTERMEDIATE MACROECONOMICS problem set I

INTERMEDIATE MACROECONOMICS I

(Economic Fluctuations)

Problem Set No. 1

(Due date: January 19, 2015)

 

Section I: Analytical Problems (40 Marks)

 

Please read the piece, \Premier Wynne says … “, published in The Globe

and Mail on January 5, 2015 as attached at the last page herein. Answer the following questions in view of the above piece, and the Aggregate demand and aggregate supply model we discussed in class.

 

  1. Premier Kathleen Wynne says Ontario is ready to shield Canada from

the economic tsunami caused by declining oil prices and sinking dollar.

Explain why Canada should expect a large economic loss caused by the

declining oil price and sinking dollar? [10 marks]

 

  1. Why does Premier Wynne expect a large economic gain from the cheap

gasoline and weakening loonie? [10 marks]

 

  1. Using the AD 􀀀 AS model, assess the validity of RBC’s claim that the

fall in oil prices will actually help Canada overall. [10 marks]

 

  1. RBC economists expect investment in the oil and gas exploration and

development industry to fall by three percent this year. What would

be, if any, the e_ects of such a reduction in investment on the Canadian

economy? [10 marks]

 

Section II: Numerical Problems (60 Marks)

 

Consider an economy described by the following AD and AS model:

 

AD : M=P = 0.05Y ;                                                                              (1)

 

LRAS : Y = 1,000  and                                                                         (2)

 

SRAS : P = 25;                                                                                      (3)

 

where, M is the money supply, P is the price level, and Y is real GDP.

 

  1. Provide an economic interpretation of the coefficient of Y in the aggregate demand equation (1). Determine the velocity of money implied by the aggregate demand equation. [10 marks]

 

  1. Suppose that central bank of the country sets the money supply at 1,000

so that M = 1,000. Determine the short-run and long-run equilibrium

values of P and Y . [10 marks]

 

  1. Now, suppose a favourable supply shock such as the decline in oil price,

reduces costs and prices so that new short-run aggregate supply function

 

is:

 

SRASnew : P = 10:                                                                     (4)

 

Determine the short-run and long-run effects of the favourable supply

shock on the equilibrium P and Y . [10 marks]

 

  1. How would your answers to part c change, if the central bank chooses to

accommodate the supply shock? What are the drawbacks, if any, of such

a decision? Please be specific. [10 marks]

 

  1. Now, suppose LRAS changes to:

 

LRASnew :  Y = 2, 000:                                                                (5)

 

  1. Explain why might the long-run aggregate supply increase. [10

marks]

 

  1. Determine the effects of the increase in LRAS on equilibrium P and

Y . [10 marks]

 

 

 

 

 

 

January 5, 2015

 

Premier Wynne says Ontario ready to play leading role in economic growth

 

By ADRIAN MORROW and JEFFREY JONES

 

Province’s manufacturing sector poised to gain on cheap gas, weak dollar while energy producers suffer

 

Premier Kathleen Wynne says Ontario is ready to shield Canada from the economic tsunami caused by declining oil prices and a sinking dollar.

 

While petroleum-dependent provinces such as Alberta are taking a financial walloping, Ontario’s manufacturing heartland is poised to take advantage of cheap gasoline and a weak loonie this year.

 

“Ontario’s economy can be a buffer,” Ms. Wynne said in an interview at her Queen’s Park office. “We have a diverse economy and it can be a buffer, in a time like this, against some of that volatility.”

 

It is a sudden shift in national fortunes. In recent years, oil-rich Alberta, Saskatchewan and Newfoundland have boomed, while Ontario has been sluggish. Now, Ms. Wynne’s province is set to lead the country in economic growth.

“I don’t wish for low oil prices and a low dollar for Alberta,” she said. “But at the same time, we want our manufacturing sector to rebound. So if that [low oil price] helps, then that’s a good thing.”

 

A new report from the Royal Bank of Canada backs up Ms. Wynne’s optimism. RBC estimates the fall in oil prices will actually help Canada overall.

 

Cheaper petroleum will boost household purchasing power in the United States by $86-billion, the report projects. Combined with a lower dollar, this should increase Canada’s exports to its largest trading partner. What’s more, Canadian consumers are reaping rewards from sharply lower prices at the fuel pump, saving an estimated $8.9-billion this year.

 

Even if they spend just half that money, it will pour billions into the economy.

 

These benefits are expected to more than offset a projected $2.1-billion drop in investment by energy companies this year.

 

“If you get consumers responding to these lower gasoline prices and you get exporters managing to respond to the strength in the U.S. economy plus the weaker Canadian dollar, it can provide a significant offset to what we’re likely going to see on the investment side,” said Paul Ferley, RBC’s assistant chief economist. “Where’s the offset going to play out? Well, certainly the manufacturing sector to the extent that they see improvement in terms of exports to the U.S., benefits from both the stronger U.S. economy and the weakening of the Canadian dollar.”

 

Over the longer term, Ms. Wynne is prepared to help Alberta get more of its oil to market. Last month, she said Ontario would not consider greenhouse gas emissions from the oil sands when deciding whether to support the proposed Energy East pipeline, which would carry crude from Alberta and Saskatchewan to Eastern Canadian refineries and export terminals.

 

She told The Globe and Mail that climate-change talks should be done separately – as part of a broader Canadian Energy Strategy to be negotiated this year – from discussions over Energy East.

 

“I’ve always separated those things. I’ve always talked about the need for a Canadian Energy Strategy, from the time I came into this office,” she said. “At the same time, I’ve talked about the Energy East project, I’ve talked about that pipeline project as one that we needed to do right but that we needed to work with Alberta.”

 

“Alberta’s well-being and Ontario’s well-being are interconnected, so we want everyone to be doing well,” she said.

 

Alberta will need all the support it can get if oil prices continue their slide.

 

RBC economists expect investment in the oil and gas exploration and development industry to fall by three per cent this year, from an estimated total of $71.6-billion in 2014, assuming West Texas Intermediate oil averages $65 a barrel. WTI crude fell 58 cents to settle at $52.69 a barrel Friday.

 

Numerous energy companies have already announced sharply lower capital spending for the year – with some already cutting budgets more than once – due to crude prices that fell 46 per cent through 2014. Longer-term oil sands and offshore projects were among the first to be delayed.

 

Investment in oil and gas and related industries, such as pipelines and oil-field services, has amounted to a third of the business outlay in Canada. However, that was less than 5 per cent of total Canadian GDP, as all business investment makes up 13 per cent of GDP, according to the report. A 3-per-cent drop in energy spending would cut GDP growth by 0.1 percentage points. A 10-per-cent drop would still mean a modest 0.3-percentage-point hit to GDP growth.