1 Suppose you are hired as an economic consultant to the US government concernin

Question

1 Suppose you are hired as an economic consultant to the US government concerning public assistance policy for the "unemployed in the current economic downturn". The government is considering two policies: 1) in kind transfers of paper vouchers to families that can be exchanged for food or 2) a direct cash payment (of an amount equal to the value of the paper vouchers) that can be used for any purpose. A family cannot receive both. (Be sure to use the theory of consumer choice in your answers.)

a) Which program do you think most families would choose?

b) Why?

c) Which program makes families better off?

d) Why?


2 The table below gives the total utility that Newt receives from consuming whisky (utility measured in USD):

Glasses of Whisky Total Utility

0 $0
1 6
2 11
3 15
4 18
5 20
6 21
7 21

a) Calculate and graph the marginal utility (in USD) from each glass of whisky.

b) If the price of each glass is $5 (Newt is only interested in consuming single malt whisky), how many glasses will he purchase?

c) If the price falls to $3, how many glasses will he purchase?

d) Show how the MU curve relates to the demand curve in a separate diagram.

e) Suppose that the price per glass of whisky is $2. How many glasses will Newt buy at that price?

f) How much will Newt pay in total for these glasses of whisky?

g) What is the maximum amount that Newt is willing to pay to consume five glasses of whisky?

h) What is the difference between what Newt is willing to pay and what Newt actually pays to consume five glasses of whisky called? Show this result graphically.

Explanation / Answer

This recession has become the longest and deepest economic downturn since the Great Depression. We now have data covering 17 months of the recession. In order to see how this recession stacks up against previous post-war recessions, we compare labor market indicators at the start of recessions to their values 16 months later. This document will be updated on July 10 to reflect new June data. While the current unemployment rate — 9.4% in May — is not at an historical high, it has increased much more rapidly during this recession than in other post-war recessions. Table 1 shows the unemployment rate at the start of each recession over the last 50 years along with the unemployment rate 17 months later. The unemployment rate increased 4.5 percentage points in the first 17 months of the current recession, a far steeper increase than any of the previous recessions. In particular, during the first seventeen months of the deep recession of 1981/1982, the unemployment rate increased only 3.6 percentage points. In other words, while the unemployment rate was higher during the early 1980s than it is today, it was also much higher going into the recession. U.S. workers in the early 1980s saw a smaller increase in unemployment than what workers are experiencing today. Figure A shows this graphically; the unemployment rate at the onset of the current recession was at a lower level lower than both the 1981 and 1990 recessions. But it has increased much more dramatically. Furthermore, while the labor market has shed 6 million jobs since the start of the recession, it is important to keep in mind that in those 17 months, the population has continued to grow. Just to keep up with population growth, the economy must add approximately 127,000 jobs every month, which means over 2 million jobs, should have been added over this period. In other words, the economy is now 8.2 million jobs below what is needed to maintain pre-recession employment levels. Total hours worked in the economy is a more comprehensive measure of labor market weakness than employment because it captures both job loss and reductions in hours for workers who keep their jobs. Table 3 shows an index of aggregate weekly hours of production and nonsupervisory workers on private nonfarm payrolls at the start of each recession over the last forty years along with its value 17 months later. Again, aggregate hours during the current recession are falling at a faster rate than in previous recessions; over the course of this recession, aggregate hours have fallen 8.1%, whereas in the first 17 months of the recession of 1981/1982, aggregate hours fell by 6%

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