Summer 2022 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: None

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
Global supply-chain disruption.
[This question carries a total of 20 marks]

Global supply chains are networks of providers dis-

persed across countries that supply goods and
services to domestic firms. These chains were
severely disrupted during the Covid pandemic.
The graph on the left (from The Economist) shows
some measures of the disruption of the global sup-
ply chains during 2020-2021.

(a) Assume that a G7 economy can be well rep-

resented by the Solow growth model. Explain
how a permanent global supply-chain dis-
ruption affects the economic growth of this
country, by assuming that before the disrup-
tion the economy is in steady state. Which
parameter of the model will be affected by
the disruption? What happens to the steady
state of capital per worker? What happens to
the growth rate of GDP per worker after the
disruption happens? Make use of diagrams
and equations to explain your reasoning.
[10 marks]
(b) How would your answer change if the disrup-
tion were temporary and lasted only a couple
of years? Assume the economy is in steady
state before the disruption starts. What will
happen to the growth of GDP per worker over
time? Make use of diagrams and equations
to explain your reasoning. [10 marks]

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Question 2
Furlough [This question carries a total of 20 marks]
Many countries during the pandemic have used job retention schemes, where the workers won’t
lose their jobs and the government will subsidise their wages while the crisis lasted. An example
was the UK furlough system, which paid for the salary of workers mostly in the hospitality sector
for several months, avoiding their dismissal even if they were not working and their company was
effectively not operating. The empirical evidence collected during the pandemic suggests these
schemes have achieved their objectives without affecting other aspects of the labour market.
Imagine that the furlough scheme becomes a permanent feature of the labour market of the UK.
(a) Using the analysis of labour market flows and the concept of natural rate of unemployment,
explain how this job retention scheme will affect the labour market flows. [6 marks]

Compare the furlough scheme with:

(b) employment protection legislation (EPL) [7 marks]
(c) unemployment benefits. [7 marks]
When making the comparison, explain how these labour market institutions affect labour market
flows, and what the consequent effect is on the natural rate of unemployment. Support your reason-
ing using equations and diagrams as needed.

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 Section B
(Answer ALL questions)

Question 3
Economic growth [This question carries a total of 60 marks]
You are advising the Prime Minister on how to improve the living standards of the country. In a work
meeting held a few months ago in the Downing Street garden (not a party, just wine and cheese),
you managed to convince him that economic growth mostly comes from increases in total factor
productivity. You are now trying to figure out what possible policy recommendation you can give to
the Prime Minister.
You have written down the following simplified version of the Romer model for the UK economy.
Output is produced using labour Lyt and ideas At according to the production function

Yt = At Lγyt (1)

where 0 < γ < 1 is a parameter.

New ideas are created according to the following equation:

∆At+1 = zAt Lat (2)

where Lat is the number of workers in the research sector, and z is the productivity of the research
sector.
We also have that labour force is constant and equal to L, with Lyt + Lat = L and both Lyt and Lat
are a constant fraction of the labour force:

Lyt = (1 − `)L, Lat = `L (3)

[IMPORTANT: in all your answers make sure to explain your reasoning. We will penalise answers
that only contain calculations without any explanation.]
(a) Show mathematically what kind of returns to scale the production function exhibits.
[10 marks]
Y
(b) Derive an expression for yt = Lt , i.e. the GDP per worker. [10 marks]
(c) Calculate the growth rate of GDP per worker. [10 marks]
(d) The first policy that you consider is to buy better computers and laboratories for the researchers,
therefore increasing the productivity of the researchers, i.e. z . Show, in a diagram where on
the horizontal axis you have time, and on the vertical axis you have the natural logarithm of
GDP per worker, how this increase in z will affect the path of yt over time. Explain why this
happens. [10 marks]
(e) Another policy that you consider is to give scholarships to students that want to do a PhD,
therefore increasing `. Show, in a diagram where on the horizontal axis you have time, and on
the vertical axis you have the natural logarithm of GDP per worker, how this increase in ` will
affect the path of yt over time. Explain why this happens. [10 marks]
(f) The Prime Minister very likely has an election coming up this year, and therefore he is very
worried about the short run consequences of policy changes. Taking this into account, which
one of the two policies do you think the Prime Minister will prefer? Explain. [10 marks]

END OF PAPER

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