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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.Problem 1: Difference-in-Differences in Labor Markets (15 points) The following question is adapted from a particularly foundational economic paper. You may ignore issues of statistical significance. On April 1 of [YEAR], USA State B's minimum wage increased from $4.25 to $5.05 per hour. In neighboring USA State A, no such change occurred. Before and after this minimum wage change, economists surveyed 410 fast-food restaurants in these two states, measuring metrics involving employment, meal prices, and operating hours. One particularly important statistic that they calculated was a measure of labor quantity called Full-Time Employment, or FTE. For a firm, FTE is equal to the number of full-time employees and managers times 1 plus the number of part-time employees times 1/2. Here are the average FTEs for fast-food restaurants in these regions in February and November: State A State B February 23.33 20.44 November 21.17 21.03 Part A (5) Ignoring State A for a moment, what do you think about these data points for State B? Based on the minimum wage change, are they what you would have expected? In 1-2 sentences and a graph, explain why or why not. Assuming that this was the only major economic policy instituted by State B's congress during this time, suggest one possible confounding factor that would make you hesitant to draw strong conclusions from these two data points alone. As any statistician would tell you, correlation does not equal causation! But what if we want to derive an estimate of a causal effect? One important concept in establishing such a relationship is the counterfactual. This is "what would have happened if policy change X had not really occurred". In this case, the counter- factual in our minimum wage experiment is "the average FTE in State B in November if the minimum wage had stayed the same". However, since we don't have access to a time machine (yet), we cannot observe the true counterfactual. One assumption we use to simulate a counterfactual is the parallel trends assumption. Assigning one observational group as the "treatment group" and another observational group as the "control group", this assumption states that, regardless of any differences in outcomes before the treatment, the two groups are similar enough that, if the treatment had not occurred, we would have expected these outcomes to change over time in the same way. Part B (3) Using State B restaurants as a treatment group and State A restaurants as a control group, assess the parallel trends assumption in FTE. Give 1 reason why it might be reasonable, and 1 reason why it might not be. (HINT: Another way of saying this is: "if the minimum wage increase had not happened, the 'counterfactual trend in B' shown on the graph on the next page is a reasonable guess as to what the average FTE would've been in State B in November") Suppose that we are sufficiently convinced that the parallel trends assumption holds in this case. Now, we can solve for the causal effect size of this policy change with the difference-in-differences (DID) method. The DID estimator is the difference in the outcome in the treatment group before and after the treatment date minus the difference in the outcome in the control group before and after the treatment date. In mathematical terms, this is: DiDy = (Yafter,treatment - Ybefore, treatment) - (Yafter,control - Ybefore,control) Part C (4) Using the data on page 1, find DiDATE for the minimum wage experiment. Once you've done so, mark it on the graph on the next page (which is not to scale). Does this result strengthen or weaken your assertions in part A? Explain why in 1-2 sentences. 2 Labour Supply Treatment Trend in A Trend in B Counterfactual Trend in B Feb Nov Time When it was published, the paper made a huge splash in the social science community because of how it contradicted our typical economic intuition (which you probably cited in your answer to part A). However, as economists, we must always consider external validity. This is the extent to which we can apply the results of our studies in other contexts. Part D (3) Suppose that, next week, you are hired as a policy analyst serving the state of Mato Grosso, a largely agricultural region in western Brazil. Give two specific reasons why you might hesitate to directly apply the results of this study to your policy recommendations.Problem 2: Fiscal Policy with Inequality (10 points) In this problem, we consider an economy with two types of consumers: poor and rich. We will consider the comparative effects of two different short-run growth policies in a Keynesian framework. Consider the following stylized (closed) economy. There exist a continuum of consumers with identical utility functions but different endowments: some proportion 0 > ; of them are poor, with endowment co = er and another proportion (1 -0)