Transcript Document
1.
[11 pts total]
Assume the U.S. economy is currently
operating at an equilibrium below full employment
.
(a)
[3 pts]
Draw a
correctly labeled graph of AD/AS
, & show each of the following .
(i)
Long-run AS
(ii)
Current equilibrium output & price level LRAS SRAS 2 SRAS 1 [The 3 pts would be for drawing the AD/AS graph, drawing the LRAS, and showing equilibrium below full employment.] AD 1 E 2 PL 2 PL 1 E 1
(b)
[2 pts] Y 2 Y R Y* Real GDP
Now assume a major
production input significant increase in the world price of oil
for the U.S. Show on your graph in part , a (a) how the (i)
increase in the oil price affects Short-run AS
each of the following in the SR.
Decreases as shown above [1 pt for showing decr in SRAS]
(c) (ii)
Real output & PL [2 points] Real output decreases & PL increases as shown [1 point]
Given your answer in part (b), explain
what will happen to unemployment in the U.S. in the short run
.
Answer (c) As indicated by Y2 in the graph, unemployment will increase due to the decrease in output caused by the decrease in AS.
[2 points]
(d)
[3 pts]
Assume that the U.S. trades with Japan. Draw a
correctly labeled graph of the foreign exchange market for the U.S. dollar
. Based on your indicated change in real output in part (b),
show and explain how the supply of the U.S. dollar will be affected in the foreign exchange market
.
D
$ S 2 $
S
1 $ [3 pts for correct graph showing decrease in supply, which results in a decrease in import demand.] Y110 Y100
E 2 E 1
Answer (d): The decrease in real U.S. output will cause job losses in the U.S. and decrease the dollars supplied for Japanese goods, that is, decrease import demand.
Quantity of Dollars
(e)
[1 point]
Given your answer in part (d), indicate
what will happen to the value of the U.S. dollar relative to the Japanese yen
.
[1 pt for depreciation] Answer (e): Due to the decrease in supply of U.S. dollars [as shown above], it will take more yen to purchase a dollar, depreciating the yen and therefore appreciating the dollar.
2.
[8 total points]
Interest rates are important in explaining economic activity.
(a)
[3 pts]
Using a correctly labeled graph of the money market, show how an
increase in the income level will affect the nominal interest rate
in the short run.
D
M1 D M2
MS
[3 points for drawing correctly labeled graph, showing an increase in D m and the nominal interest rate rising.] IR 2 IR 1
Money Market
Answer 2 (a): An increase in income will cause more consumption in the economy which will push up demand [to D M2 above] for money which will increase the nominal interest rate [to IR 2 ].
2 (b)
[3pts]
Using a
correctly labeled graph of the loanable funds market
, show how a
decision by households to increase saving for retirement
will
affect the real market interest rate
in the short run.
D S 1 S 2 r 1
r
2 E 1 E 2 [3 points showing correctly labeled graph, showing increase in supply & real I.R. dropping.]
F 1 F 2
Quantity of Loanable Funds
Answer 2 (b): If householders save more the banks have more money to loan out [ S2 ] which would decrease the real interest rate [to r2 ].
[
Real I.R.
+
anticipated inflation
=
nominal I.R.
]
+
2 % 6 %
=
8%
Real Interest Rate Inflation Premium Nominal Interest Rate
[
Nominal I.R.
–
inflation rate
=
Real I.R.
]
-
2 % 8 %
=
6 %
Nominal Interest Rate Inflation Premium Real Interest Rate
2 (c) [2 pts] S uppose that the
nominal interest rate
If
inflation is now expected to be 2% , has been
determine the
6%
with
no expected inflation
.
value of each
of the following.
(i) The
new nominal interest rate
(ii) The
new real interest rate Answer 2(c)(i): The nominal interest rate is 8%.
[6% real + 2% expected inflation premium ] Answer 2(c)(ii): The new real interest rate would be 6%.
[8% new nominal interest rate – 2% anticipated inflation = 6% real I.R.] [*A point was also given here if the student says the real interest rate is 2% less than whatever they said the nominal was] 6 %
Real
I
.Rates
3. [7pts] T he
unemployment rate
is an important indicator of the health of the U.S. economy.
(a) [1 pt] Assume that with the
economy at full employment
, the government implements an
expansionary fiscal policy
. How does the
actual unemployment rate at the new short-run equilibrium compare with the natural rate of unemployment
?
LRAS AD 1 AD 2 SRAS PL PL 2 1 E 1 E 2 Answer 3. (a): Actual output [ Yi ] would exceed the natural output rate [ Y* ] at the new shor-run equilibrium [ E2 ]. Therefore, the actual unemploy ment rate [ 4% ] would be lower than the natural rate of unemployment [ 5% ].
Y*
5 % Y i 4 %
(b) [2 pts] Assume that a significant number of
workers are involuntarily changed from full-time to part-time employment
. Explain how this will affect the number of people who are officially classified as unemployed.
Answer 3. (b): The official unemployment rate would not change because part-time workers are also counted as fully employed.
3 (c) [4 pts] Assume that the
government reduces the level of unemployment compensation
.
(i) Explain how this
affects the natural rate of unemployment
.
(ii) Using a
correctly labeled graph
, show how this
affects the long-run P hillips curve
.
PL
LRPC 2 LRPC 1 [4 points given for saying the a.) natural rate will fall, b.) People have more incentive to look for work, c.) graph of LRPC, and d.) leftward shift of the LRPC] Y 2
Y
1
Unemployment
Answer 3(c): (i): The natural rate of unemployment would decrease to Y 2 because of “more labor” in the work force. (ii): Lower payment for unemployment compensation will mean that workers have more incentive to work and go out and search for jobs more quickly. They remain unemployed for shorter periods of time and hence the natural rate of unemployment tends to be lower. The LRPC would shift to the left to Y 2 .