1.(a) Suppose that an economy is hit with an adverse oil shock (a rapid increase in the price of oil). Use the labor market and the production function (draw graphs and clearly state) to show the predicted effects on employment, wages, unemployment, and real GDP.

(b) Consider the following data for Japan in early 1970s:

Note that oil prices about tripled in 1974. Are your predictions in (a) consistent with the Japanese experience of the mid1970s? What is or isn’t consistent?

2. (8 pts) Following rapid increase in the number of unemployed people in the mid1970s, suppose that the Japanese government wanted to stimulate the economy by using fiscal stimulus (increase in government expenditure or a decrease in income taxes). Use the Goods Market (draw graphs and clearly state) to show the predicted effects on the interest rate, level of savings, and level of investment if we assume that: (a) Japan is a closed economy.

3. (5 pts) Following rapid increase in the number of unemployed people in the mid1970s, suppose that they wanted to stimulate the economy by using monetary stimulus. What type of policy would they conduct to stimulate the economy?

Part 2 (15 points total) 1. Use the following information about the labor market:

W=100-N

W=10+2N

Y=A*K.5N.5

a) Graph each of these curves. Make sure to completely label the graph and indicate which curve is the labor supply and which is labor demand.

b) What is the market-clearing wage? Suppose that no worker is willing to work for less than $0. What are the employee (sum of the difference between what someone would work for and what they get) and employer surpluses (sum of the difference between what a firm would pay and what they do pay the workers)? Hint: the surpluses are areas (triangles, squares, trapezoids etc)

c) Suppose that A=1 and K=1. Graph the production function. Given the number of workers you found in b) what is the output that is produced?
 

1971 1972 1973 1974 1975 1976 Oil Price ($/Barrel) 2.57 2.80 3.14 11.22 10.60 11.83 Employment Unemployment (1000s of persons) 51216 51242 52595 52364 52228 52705 645 736 668 722 1004 1074 Real Wage (growth rate) 8.03% 9.60% 7.52% 2.31% 4.02% 1.26% Real GDP 1985 Yen 178993 193712 208484 207197 213122 222098