1. Life-Cycle Theory and Demographic Change
Demographers predict that the fraction of the population that is elderly will increase over the next 20 years.
a. What does the life-cycle model predict for the effect of this demographic change on the national saving? Explain.
b. Based on your answer in part (a), use the Savings-Investment diagram to illustrate graphically the impact of the demographic change on the real interest rate and the investment. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction curves shift; and v. the terminal equilibrium values.
2. Government Purchases, Richardian Equivalence, and Investment
Economists often argue that a temporary increase in government purchases – say for military purposes – will crowd out private investment. Use the saving investment diagram to illustrate this point, explaining why the curves shift. Does this matter whether the temporary increase in military spending is funded by taxes or by borrowing?
Alternatively, suppose that the temporary increase in government purchases is for infrastructure (roads, sewers, bridges) rather than for military purposes. The government spending on infrastructure makes private investment more productive, increasing the expected future MPK at each level of the capital stock. Use the saving investment diagram to analyze the effects of government infrastructure spending on current consumption, national saving, investment, and the real interest rate. Does investment by private firms get crowded out by this kind of government investment? If not, what kind of spending if any does get crowded out? Assume that there is no change in current productivity or current output and assume (for simplicity) that household do not expect a change in their future incomes.
3. Real Wage Rigidity and Unemployment
Assume that the real wage in an economy is held above equilibrium.
a. Graphically illustrate how an increase in the supply of labor will change the number of unemployed workers. Be sure to label the axes and the quantities of labor hired before and after the change.
b. Explain in words what happens to the number of unemployed as a result of this change.