UNIVERSITY OF CAPE COAST COLLEGE OF HUMANITIES AND LEGAL STUDIES SCHOOL OF ECONOMICS DEPARTMENT OF APPLIED ECONOMICS END-OF-SECOND SEMESTER EXAMINATIONS 2020/2021 ACADEMIC YEAR ECO 422: ADAVANCED MACROECONOMICS DATE: Mon. 27" Sept., 2021 INSTRUCTION: ‘© The paper has three sections: A, B and C. « Candidates are to answer four questions in all. © Questions 1 and 2 in section A are comipulsory © Candidate are to answer ONE question each from Sections B and C. . © NOTE: Each candidate will be given two answer booklets. Questions 1 and 3 or 4 should be in the same booklet Questions 2 and 5 or 6 should be in the same booklet fe SECTION A Answer All Questions from this Section Question 1 Consider an economy populated by agents where the households optimisation problem during a Covid-19 period (et me eS eas = Ack — ce Subject to Where ye = Ack, cis output and is the share of capital in output. Technology shock, Ay; follows an AR process, Indy = palnAe—a + 6:5. & is a serially uncorrelated, i.i.d, and normally distributed shock with mean zero and standard deviation a4. p4 is the autocorrelation coefficient. () Using the assumptions that MP, = Reva = @AekP"* = 3 and c= wAdk find the equilibrium output, consumption and capital and trace how a one standard deviation of 1Gi) negative Covid-19 like (technology) shock will impact on these real variables. How do your impulse response functions (IRF) behave? (7 marks) How will this result look like if pa 0.90, @ = 4/5? How will you describe the shape of your IRF? (4 marks) Gii) Now assume that py = 0 and consider the effect of a one time (temporary) negative technology shock. Assume that the share of capital, a = 4/5. Let yp be the output at time £— 1. Suppose further that at time T a negative technology shock is realized and let er = 1 Suppose that the shock is entirely temporary, ie. ¢; = 0 Vt > T. What would be the response of output, capital and consumption? (4 marks) Question 2, Consider a two-sector open economy resided by identical households. Each household is endowed by capital and labor. There are two firms operating in this economy. Firm 1 operates in the primary sector that produces food, clothes and shelter. Firm 2 operates in the secondary sector, it supplies household and invest those to replenish capital. This economy trades with the rest of the world (ROW), exports some of the products and import some from ROW. Household receive labor and capital income by suppl 1@ their labour and capital endowments to the producers. Government imposes taxes on labour income and uses tax receipts to purchase goods, A hypothetical data set for this economy is given in the following input-output table. Primary | Secondary | C T G x mM Total Primary | 15 25 50 10 10 5 -15, 100 ‘Secondary | 20 25 70 20 5 15 5 150 ‘Labour | 45 35 100 Capital | 15 35 50 Taxes 5 10 15 Total 100 150 0 [30 15, 20 20 (a) Write down a simple utility function for a representative houschold for this economy. (marks) (b) What will be the profit function for firms operating business in the primary and secondary sectors? (2 marks) (©) Do the demand for and supply of goods balance for each product in this economy?(3 mrks) (@ What is the total income of the representative household? How much does she consume? How much does she save? (4 marks) (©) Can you reconcile the gaps between savings and investment, goverment revenue and expenditure and export and imports? @ marks) (f) Provide a simple production function to describe production in the primary and secondary sectors of this economy. (2 marks)SECTION B Answer One Question from this Section Question 3 (a) According to the random-walk hypothesis, uncertainty about future income does not affect consumption, however, uncertainty does affect utility. Discuss how uncertainty about consumption. affects expected lifetime utility using the quadratic utility function u(c,)=—$c? as your instantaneous utility. @ marks) (b) The random-walk hypothesis argues that change in consumption is unpredictable. Discuss withthe necessary derivations (6 marks) uestion 4 8) Suppose an agent lives for only two periods, t = 1,2 and eams income ¥; and Yo, consumes C, and Cz, respectively, such that the budget constraint is Now suppose the agent invests /, and Jz, respectively, in periods 1 and 2. Agent starts with no capital so that KX, = 0, and also savings is split between investment and inter-temporal lending such that Sy = J, + B,; Bz = 0, Kz = 0, since t = 2 is the last period, and I, = —(1-5)K. ‘The Lifetime budget constraint of the agent is ¥, + F(K2) + (1-5) K, Y= ky APR) + = OOK itr Using W and 0 i) Show that investment in the economy by agents will increase wealth. (5 marks) ii) How much investment/capital maximises wealth? (4 marks) b) Suppose cy = Eeas(ce) + eri where Ey1(cr) = ¢r-1»Be-1(@) = 0. This is the famous Hall's assertion that the Permanent Income Hypothesis (PIH) implies that consumption follows a random walk (Hall,1978). Critically discuss how true this is? (6 marks)SECTION C Answer One Question from this Section Question 5 Given the following Keynesian model: Y=C+1+G (1) C=at+b¥-T) a>0,b>0 @ T=0~dr e>0,d>0 @) L,Y) =e¥ - fr e>0,f>0 @) Maun © The parameter b is the marginal propensity to consume, The parameter d determines how much investment responds to the interest rate. The value of e determines how much demand for money rises when income rises. (@) Derive both the IS and the LM curves. (4 marks) (b) Derive the aggregate demand curve and illustrate it on a well labeled diagram.(3 marks) (©) Docomparative statics with respect to the fiscel policy variables and explain your answer. (4 marks) @ Consider an economy in the IS-LM-BoP, AD- AS framework in a flexible exchange rate regime with variable domestic price and perfect capital mobility. Using appropriate diagram(s), discuss the effect of an increase in government spending on equilibrium | national income and interest rate and the price level. (4 marks) juestion 6 ‘Imagine an economy of three sectors which is characterised by the following activity levels and trade flows: x] [100] fan x2 xs] flO 30 10] [4] [50 x |=|200], |x x2 |= {30 50 20), |», |=|100 x} [100] [x x2 x] [10 20 20} Ly] 50 (a) Construct the complete input-output table including a row for the value-added to each sector by factor services, and confirm that the various accounting identities have been met in the construction of the table. 3 marks) (b) Calculate the matrix A = |a, | of the input-output coefficients. (@ marks) (©) Verify the Hawkins-Simon condition. @ marks) (@) Use the Cramer’s method to solve the equation (J - A)x = y to find the vector x= [x,,,,%] of the activity levels in the 3sectors when the levels of final demand are given by y=[y,92.95] = [60,120.60]. (6 marks)