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1) In the following problem, use appropriate diagrams to show the changes in producer and consumer surplus as the situation evolves. a) Begin with a market for rice in the small country of Buras. The Buras rice market is supplied only by domestic farmers with differing cost curves so that the rice industry has a standard upward sloping supply curve. Consumers have a standard downward sloping demand curve and market equilibrium is reached at $1.05/lb. Illustrate the consumer surplus and producer surplus in your diagram. b) Now assume that the Buras opens itself up to international trade. The world market price for rice is $.90 per pound. Because Buras is small, its demand will have no effect on the world price so you can assume it faces an international supply curve for rice that perfectly elastic at $.90 per pound. Show what changes occur in Buras consumers' surplus and the Buras farmer's producer surplus because of this international trade. (Do not consider the producer surplus of farmers in other countries). c) Bowing to the protests of Buras rice farmers, the government imposes a $.15 per pound tariff on imported rice so that each pound of imported rice has $.15 added to its price. Using appropriate diagrams show what changes this tariff makes in the consumer surplus and Buras farmers' producer surplus you had in (b). Can you identify the tariff revenue in your graph?Part I. True/False/Uncertain Justify your answer with a short argument. 1. High unemployment implies that the labor market is sclerotic. 2. Patty lives in the US, and her salary at Widgets-R-Us is $25,000 per year. Suppose she is offered to move to France to work at a Widgets-R-Us franchise in Paris. Her new salary would be $35,000. Assume over the course of her move inflation in both countries will be zero, and Patty will not incur any moving costs or any other costs associated with going to France. Assume also that the two jobs she will be doing are completely identical. Patty should move, because she is going to get a higher salary. 3. When output is below the natural level of output, the actual price level is lower than the expected price level. 4. Suppose there is a decrease in the price level from P to P' . Given the stock of nominal money, M, this leads to an increase in the real money stock, M/P, which shifts the LM curve down. This implies that the AD curve shifts to the right. 5. In terms of changing output, monetary policy is relatively more effective when the AS curve is relatively flat, while fiscal policy is more effective when the AS curve is relatively steep. 6. The neutrality of money means that monetary policy cannot affect output.Part II. Aggregate Demand and Aggregate Supply In the first quiz, you have found that the IS relation is given by Y = Co +b. + G 1-c(1-t) 1-c(1-t) and that the LM relation is given by i = -(m. M' m2 P -+ m,Y) in the Republic of Keynesia. Let 1-c, ( 1-t ) -= A for simplicity. 1. Derive the expression for aggregate demand using the above equations. Is the AD curve upward- or downward-sloping? 2. Show (mathematically) that output, Y, is an increasing function of the real money stock, M/P, and an increasing function of government spending, G. 3. Let: Co = 200 mo = 400 G =100 CI = 0.5 m = 1 1=0 bo = 300 m2 = 0.8 Y,=550 b1 = 0.4 M = 200 Derive the AD equation using these figures. (All figures are in millions of US dollars.) 4. Suppose the aggregate supply takes the following form: P = (1.5)P* + (1/50)(Y - Y, ) and P=1. Assume we are in the short-run for now. What is the equilibrium output, Y*? What is the expected price level, P"? Draw the AS-AD diagram. 5. The Keynesian government is up for reelection soon, and so it wants to achieve the natural level of output. (We are still in the short run.) Propose two different policy options that would do the job. For each policy option, draw the IS-LM and the AS-AD diagrams, and show how the first translates into the second. Calculate by how much the government must increase/decrease government spending to achieve the natural level of output. 6. The Keynesian government decides not to listen to you, and raises government spending by more than would be required to achieve the natural level of output. Its argument is that higher output is better. The voters apparently think so too, and the government gets reelected. What happens as time passes and we get to the "medium run"? (You do not have to do any calculations, just draw diagrams and give some intuition.) 7. Suppose the world price of oil increases. Use a diagram to show what will happen in the Republic of Keynesia, starting with the new medium run equilibrium you found in part 6. Part III. The Phillips Curve Suppose the Phillips curve is given by a, = 1, +0.2-5u, where a, = On, 1. What is the natural rate of unemployment in this economy? 2. For now assume that 0=0. (What does that mean?) Suppose that the government decides to lower unemployment to 3% and keep it there forever. What is the rate of inflation for t=100? Is this realistic? Why? 3. Assume that only for the first three periods (t=1, t=2, and t=3) people form their expectations using 0=0. After the third period, from t=4 on, they start using @=1 forever. Also, the government still wants to keep unemployment at 3%. What is the rate of inflation for t = 4, 5, and 6? What is the expected rate of inflation for t=4, 5, and 6? Is this setup more realistic? Why?Part I. True/False/Uncertain Justify your answer with a short argument. 1. A higher saving rate alone can sustain higher growth of output forever. 2. The golden-rule level of capital tells us that the highest level of consumption in steady-state is achieved when the saving rate is equal to 0. 3. A flexible exchange rate regime is superior to a fixed exchange rate regime. Part II. Open-Economy AS-AD EP * Real exchange rate: P i- rate parity condition: i = i*+ E E IS: Y= C(Y, T) + I (Y,i) + G + NX (Y, Y*, E) LM: M' = M" (Y, r)P 1. Suppose the economy is at point A where Yo