An article in the Washington Post, dated August 4, 1990, stated that "[o]il prices continued to surge yesterday in the wake of the Iraqi invasion of Kuwait, jarring world financial markets and increasing the danger that the U.S. economy will drop into a recession. That danger was underscored yesterday by a Labor Department report that the nation's civilian unemployment rate rose from 5.2 percent to 5.5 percent last month, ... Crude oil prices took another jump of $1.50 to $2 a barrel, ...,[t]hat would translate into a 15 cent-per-gallon increase in gasoline prices at the pump, and similar increases in home heating oil prices, feeding a powerful current of inflation into the economy.

1. Write down the quantity equation and explain it. What does the assumption of constant velocity imply about the inflation rate?

2. Robert Reich recently suggested that the U.S raise its minimum wage from $4.25 per hour to $4.75 per hour. Others in the Clinton administration have suggested that the minimum wage be increase to $6.00 per hour. Briefly discuss the advantages and disadvantages of such a policy.

3. Explain the dynamic effects of such a change on the U.S. economy. What happens to real output growth and the level of real output in the long run?

4. Why does real output change if there is no change in national saving?

5. Fully explain the immediate impact of such a change on the following variables:

world real interest rates; U.S. real interest rates; investment in the U.S.; the current and capital accounts in the U.S.; and the real and nominal exchange rate measured as Rest of World Currency per U.S. dollar.