SOLUTION: ECON 3P04 UOL What Is the Equation for This Economys Feasible Set Discussion

ECON 3P04 Assignment 2
February 18, 2021
Instructions: Please write out your answers clearly, and submit them by 2pm EST on
Wednesday, March 3rd, 2021 (via Sakai’s dropbox feature). Show your work.
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Short Response
1. Consider an economy with a constant population of N = 100. Each person is endowed
with y = 20 units of the consumption good when young, and nothing when old.
(a) What is the equation for this economy’s feasible set (with no money)? (10%)
(b) Portray an individual’s feasible set on a clearly labelled diagram. (5%)
(c) Now consider the monetary equilibrium. Write down equations that represent the
constraints on first- and second-period consumption for a typical person. Combine these
constraints into a lifetime budget constraint. (10%)
2. Consider the overlapping generations model. Let the number of young people born
each period be constant, at N . There is a constant stock of fiat money, M . Each young
person born in period t is endowed with yt units of the consumption good when young
and nothing when old. A person’s endowment grows over time so that yt = αyt−1 , where
α > 1; that is, the young in the next period have a higher endowment than the young in
the previous period. For simplicity, assume that in each period t, people desire to hold
real money balances equal to one half of their endowment, so that vt mt = y2t .
(a) Write down equations that represent the constraints on first- and second-period
consumption for a typical person. Combine these constraints into a lifetime budget
constraint. (10%)
(b) Write down the condition that represents the equilibrium in the money market in
period t. Use this condition to find the real rate of return of fiat money in a monetary
equilibrium. Explain the path over time of the value of fiat money. (15%)
(c) Show that yt = (α)t y0 . (10%)
3. This question refers to the gold standard. There were three periods of the gold
standard: The 19th Century classical gold standard, the interwar gold standard, and
Bretton Woods.
(a) Carefully distinguish between the three types of monetary systems, with reference
to the international political coordination required in each one. (15%)
(b) Consider the quantity theory of money. If economic growth occurs, what happens
to the price level? (10%)
(c) Under the classical gold standard, international trade had little impact on inflation
due to the price-specie-flow mechanism. For example, if Country A bought from Country
B, then gold would be exported from A to B in order to settle payments. With reference
to the quantity theory of money, why would this stabilize prices across countries?1 (15%)
Hint: the equation for economic growth is Y = C + I + G + N X. The last term, N X, is shorthand
for ”net exports,” which is Exports minus Imports.

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