Summer 2023 Exam

EC1B3
Macroeconomics I

Suitable for all candidates

Instructions to candidates

This paper contains 2 sections. Section A contains 2 questions. Section B contains 1 question.
Each question and subquestion indicates how many marks the answer will carry.
Answers should be justified by showing work.
You have to answer ALL questions.

Time Allowed Reading Time: 15 minutes

Writing Time: 2 hours

You are supplied with: No additional materials

You may also use: No additional materials

Calculators: Calculators are allowed in this exam

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 If during this examination you feel you need to make additional assumptions in order to proceed,
then please do so stating your assumptions clearly.

Section A: Short questions

(Answer ALL questions.)

Question 1
Ricardian equivalence? [This question carries a total of 20 marks]
In a two-periods economy with perfect credit markets, the government expenditure is equal to G1 =
G2 = Ḡ in both the first and second period. The real interest rate is r. Each consumer has an in-
come of y1 = y2 = ȳ in both periods and pays t1 and t2 in taxes to the government respectively in
period 1 and 2. Each consumer can consume in both periods (c1 and c2 ). Assume there are N iden-
tical consumers in this economy, and their preferences are identical and represented by standard
indifference curves.
(a) The government decides to increase government spending by an amount X > 0 in the first
period, while at the same time reducing by the same amount X > 0 in the second period.
Therefore G1 = Ḡ + X and G2 = Ḡ − X after the policy change. The government also makes
sure that their intertemporal budget constraint is satisfied after the changes in government
spending. Do you expect consumers to change their optimal choice? Explain your answer with
the help of equations and diagrams if needed. How does this relate to the Ricardian equiva-
lence? (HINT: is this policy change revenue-neutral?) [10 marks]
(b) Assume now that we are back to the initial situation with government spending being equal to
Ḡ in both periods. Due to limited commitment, consumers cannot borrow at all. The govern-
ment decides to increase government spending by an amount X > 0 in the first period, while
at the same time decreasing it by the same amount X > 0 in the second period. Therefore
G1 = Ḡ + X and G2 = Ḡ − X after the policy change. The government also makes sure that
their intertemporal budget constraint is satisfied after the changes in government spending.
Assuming that all consumers were choosing the endowment point before the change in gov-
ernment spending, is it possible they could consume more in the first period after the policy
change? Explain your answer with the help of equations and diagrams if needed.
[10 marks]

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Question 2
Labour market flows [This question carries a total of 20 marks]
The labour market in Winterfell is characterized by the labour market flows in the following diagram.
Each circle represents the pool of respectively U(nemployed), E(mployed) and I(nactive) workers. To
each arrow corresponds a probability of moving from one state to another. For example, the prob-
ability of moving from unemployment to employment is given by f , while the probability of moving
from inactivity to employment is ℓ.

(a) Explain what each of those arrows means, possibly giving a concrete example: e.g., the arrow
from I to U capture which type of transition in the labour market? Which workers would be rep-
resented by this arrow? [10 marks]
(b) Write down the equations that describe the labour market flows of unemployed, employed and
inactive workers, i.e. how the pool of unemployed changes over time, etc. (NOTE: you don’t
need to find the steady state!) [10 marks]

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 Section B
(Answer ALL questions)

Question 3
Economic growth [This question carries a total of 60 marks]
The economy of Zombieland has a production function given by Yt = ĀKtα L1−α t , where Ā is the
(constant) TFP, Kt is the aggregate capital, and Lt = L̄ is the constant number of workers. Capital
evolves according to the following equation:

Kt+1 = It + (1 − δ)Kt (1)

where It is aggregate investment, and δ is the constant depreciation rate. Savings are a constant
fraction s̄ of the production. There is no government, and the economy is closed to international
trade.

The economy gets an epidemic of the zombie virus. This virus kills workers and transform them into
zombies, so they are not workers anymore once infected. A fraction 1 − r of workers become a
zombie immediately at the start of the epidemic, while the rest is immune to the virus.
(a) Derive the steady state of aggregate capital in the economy BEFORE and AFTER the zombie
epidemics. [10 marks]
(b) With the help of a diagram, explain how the economy will adjust after the zombie epidemic
in the short and long run. Work with aggregate variables. Assume the economy before the
epidemic is in steady state. [10 marks]
(c) What will happen to the capital (and output) PER WORKER during the epidemic? Explain what
is the evolution of capital (and output) per worker from just before the start of the epidemic
until the very long run. [10 marks]
(d) In the first few days of the epidemic, several zombie attacks destroy many plants and ma-
chines. Explain how this will affect the economy in the short run, both for aggregate and per
worker variables. Would the steady states found in the question (a) and (c) change? Illustrate
your argument with diagrams. [10 marks]
After a few months of epidemic and continuous zombie attacks, all capital is destroyed. The econ-
omy now relies on the production of food with semi-primitive techniques. In particular the economy
has the following production function for food:

Yt = B̄ Utα (Lyt )1−α (2)

where Yt is food, B̄ is total factor productivity, Ut are the agricultural tools used to produce food,
and Lyt is the number of workers in the food producing sector. Agricultural tools are produced ac-
cording to the following production process:

∆Ut+1 = z̄Ut Lut − dUt (3)

where z is the productivity in the agricultural tools sector, Lut is the number of workers in the agri-
cultural tools sector, and d is the depreciation rate of agricultural tools. Assume that the total num-
ber of workers is constant and equal to L̂, and a constant share of the workers is employed in each
sector: Lut = uL̂ and Lyt = (1 − u)L̂.
(e) What happens to output per worker in the long run? Do we have a steady state? Explain your
reasoning with equations and diagrams if needed.
[10 marks]

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(f) A cure is found for the zombie virus that re-transforms zombies into workers. Therefore there
is an increase in L̂ when every zombie is cured. How will this affect the output per worker in
the short and long run? [10 marks]

END OF PAPER

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