Venkata Addanki Business Economics ECON545 Sep 2013 - Nov 2013 venkatjaddanki@gmail.

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Exercise 1 Chapter 15 Question 11: Year 1965 1975 1985 1995 2005 GDP 719.10 1638.30 4220.30 7397.70 12455.80 C 443.80 1034.40 2720.30 4975.80 8742.40 I 118.20 230.20 736.20 1144.00 2057.40 G 151.50 357.70 879.00 1369.20 2372.80 X-M 5.60 16.00 -115.20 -91.40 -716.70 C(%) 61.72 63.14 64.46 67.26 70.19 I(%) 16.44 14.05 17.44 15.46 16.52 G(%) 21.07 21.83 20.83 18.51 19.05 X-M(%) 0.78 0.98 -2.73 -1.24 -5.75

a. Which component is the most stable? The government spending (G) seems to be the more stable component with an average of 20.25% of GDP for the forty years in review. The government spending G includes the salaries and wages of government employees (federal, state and local) and the purchase of goods and services, the purchase of new structures, equipment and software. G has increased over the period, representing almost 1/5 of the GDP; it means that the government has played a stable and active role in the U.S. economy. b. Which component is the most volatile? The most volatile component has been the Net Export. Representing 0.8% of GDP in 1965, it was -2.7% of GDP in 1985, -1.2% in 1995 and -5.7% of GDP IN 2005. It also shows that the U.S. economy has been more dependent on imports. c. Ignoring the net export, which has grown the fastest as percentage of the GDP? The personal consumption expenditure C has increased from 61.72% of GDP to 70.19% in 2005. This indicates that the internal consumption has been the major drive of the growth of the economy for the period under review.

Exercise 2 Chapter 16 Question 11: Cyclical Unemployment will be a result of businesses not having enough demand for labour to employ all those who are looking for work. The lack of employer demand comes from a lack of spending and consumption in the overall economy. When business cycles are at their peak, cyclical unemployment will be low because total economic output is being maximized. When economic output falls, as measured by the GDP, the business cycle is low and cyclical unemployment will rise. It could be reduced by using demand side policies like expansionary fiscal policy of cutting taxes and increasing government spending and/or supply side monetary policy like cutting interest rates which decreases cost of borrowing and encourage people to spend and invest. Recent Cash for Clunkers is one such example which used to increase consumer spending. Structural Unemployment happens because of changes in the structure of an economy is a more longterm and chronic type of unemployment. Structural unemployment does not follow variations in the business cycle. Rather, it is caused by a discrepancy of the skills of the worker and the demand for those skills in the marketplace. Structural unemployment often occurs when there is demographic change, large-scale industrial layoffs, and/or a mismatch between skills and available jobs (i.e., due to technological advances). Government training programs, providing subsidies to firms that provide training to displaced workers, relocation services and education support for prospective employees are some of ways to reduce. Frictional unemployment occurs because it takes some time for workers find new jobs before they leave their old ones, a lot of workers leave or lose their jobs before they have other work lined up. In these cases, a worker must look around for a job that it is a good fit, and this process takes some time. During this time, the individual is considered to be unemployed, but unemployment due to frictional unemployment is usually thought to last only short periods of time. This is particularly true now that technology is helping both workers and companies make the job search process more efficient. Frictional Unemployment could be reduced by means of providing Education Advice, Computerized national job database for easy search, Incentives and regulations, Relocation of industries and services and Aids and grants to overcome specific obstacles (provisions for disabled workers etc.)

Exercise 3 Chapter 26 Question 8: A fixed exchange rate system is one where the value of the exchange rate is fixed to another currency. This means that the government have to intervene in the foreign exchange market to maintain the fixed rate. The equilibrium exchange rate may be either above or below the fixed rate. There is a shortage of the national currency at the fixed rate. This would normally force the equilibrium exchange rate upwards, but the rate is fixed and so cannot be allowed to move. To keep the exchange rate at the fixed rate the government will need to intervene. They will need to sell their own currency from their foreign exchange reserves and buy overseas currencies instead. This has the effect of shifting the supply curve and as a result, their foreign currency holdings will rise. Fixed rates provide greater certainty for exporters and importers Fixed exchange rates forces strong discipline on domestic firms and employees to keep their costs under control in order to remain competitive in international markets.

Floating exchange rate will be determined by market forces that is supply and demand. As in any other market, the rate will change constantly to reflect how much of the currency is being traded. Fluctuations in the exchange rate can provide an automatic adjustment for countries with a large balance of payments deficit. If an economy has a large deficit, there is a net outflow of currency from the country. This puts downward pressure on the exchange rate and if depreciation occurs, the relative price of exports in overseas markets falls (making exports more competitive) whilst the relative price of imports in the home markets goes up (making imports appear more expensive). Floating exchange rate resolves trade imbalance Flexibility in determining interest rates for government

References: Gerald W. Stone (2008). Core Economics First Edition 2008 Worth Publishers.

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