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The conditions confronting a typical rm are shown in the right panel in Figure 12.5. The demand curve facing this rm is a horizontal line at P* = 20. This means that it can sell as much or as little as it chooses at the market price of 20/unit. Put another way, any single rm can sell as much as it wants to without affecting the market price. If a rm charged more than 20, it would sell no output at all because buyers would switch to a competing rm that sells for 20. A rm could charge less than 20, of course, but would have no motive to do so if its objective were to maximize economic prot, since it can already sell as much as it wants to at 20. The result is that even though the market demand curve is downward sloping, the demand curve facing the individual rm is perfectly elastic. (Recall from the denition of price elasticity in ha t r 5 that a horizontal demand curve has innite price elasticity, which is what 'perfectly elastic' means.) In the right panel in Figurg 12 .5 the representative rm maximizes its prot by equating P* 20/unit to marginal cost at an ou ut level of Q1- - 30 units/wk At that output level its total revenue is 91 1,600/wk and its total costs are AT012: 0L (12/unit) (80 units/wk)= 960/wk Its economic prot 1s the difference between total revenue and total cost, 1,600/wk 960/wk = 640/wk, and is represented by the shaded Part I (Do Problem 1 - 30 points) 1. Use the following version of Model 1 to address parts a -e. Show your work. W/P = d0 -d1*L + d2*K + d3*RM (1) Endogenous Exogenous Ls = so + $1*(W/P) - $2*T (2) W, P, L, LS, Y K, RM, T L = Ls (3) AD, C, I M, K, G Y = 100*L 7K.3 (4) AD = k*M/P (5) AD = C+1+ G (6) C = .8* (Y-T) (7) Y = AD (8) a. (6) Determine the reduced form equation for employment. b. (4) Determine the reduced form equation for output (income). c. (4) Identify the Aggregate Supply curve. d. (8) In this model, how would an earthquake that destroyed a major nuclear power plant affect employment, output, real wages, and the price level? e. (8) In this model, determine how a fall in taxes (T) would affect employment, output, real wages, and the price level. 2. Use the data in the table below to answer parts a - c. (15 points) a. Use a CPI type index (Laspeyres) to determine how much prices have changed from year 1 to year 2. b. Use a GDP current weight deflator index (Paasche) to determine how much prices have changed from year 1 to year 2. c. Use a chain weighted index to determine how much prices have changed from year 1 to year 2. Year Cell Phones Computers Cars Price Quantity Price Quantity Price Quantity 1 100 100 1000 50 5000 10 2 80 150 600 100 8000 123. Exchange rates are expressed in per Euro terms. (15 points) a. (8) Based on the data in the table below, calculate the trade weighted exchange rate for the Eurozone countries for 2011 based on a 2000 year base of 100. How much has it changed since 2000? b. (7) Assuming that the price index for Europe in 2000 was 90.2 and that it presently stands at 111.5, how much has the real exchange rate between the USA and Europe changed between 2000 and 2011. Country Share of Exchange Rate Exchange Rate |Price Index Price Index Trade 2000 2011 2000 2011 China 25% 7.94 9.44 NA NA Japan 25% 102.56 121.95 NA NA USA 50% 0.96 1.44 171.3 221.3 Part II (Answer two of the following three questions - 20 points each.) Be sure to provide supporting graphics or evidence. 4. Model 1 (The Neoclassical Model) seems to provide a view of money that contradicts that posed at the top of this exam. Furthermore, many economists and policy makers argue that money has powerful effects on output and employment. Explain why these views contradict the predictions of Model 1. Briefly discuss why it is difficult to predict the effects of expansionary monetary policy on the real economy. 5. On Friday, April 1", 2011, the Bureau of Labor Statistics reported that the unemployment rate had dropped to 8.8%, that the change in non-farm payroll employment was 216,000, that the labor force participation rate was 64.2%, and that the employment ratio was 58.5%. If you were a journalist asked to explain what this information says about the labor market, how would you do so? Be sure to put these indicators in historical context. 6. What role do interest rates play in Model 1? Be sure to distinguish between real and nominal interest rates as well as how they are determined. Explain the connection between interest rates and crowding out.7. Suppose that the Federal Reserve acts to increase the money supply. a. In the aggregate demand/aggregate supply diagram, will this monetary policy action work initially to shift the aggregate demand curve, the short-run aggregate supply curve, or the long-run aggregate supply curve? (Note: focusing for now on just the short-run effects of the change in policy, only one of these curves will shift.) b. In which direction will the curve you mentioned above shift: to the left or to the right? When the curve you mentioned above shifts, what will the short-run effect on the economywide level of prices be: with it rise, fall, or stay the same? d. When the curve you mentioned above shifts, what will the short-run effect on real GDP be: will it rise, fall, or stay the same? e. When the curve you mentioned above shifts, what will the short-run effect on unemployment be: will it rise, fall, or stay the same? 8. This last question builds directly on the previous one. Suppose that after observing the short-run effects of the increase in the money supply, the Federal Reserve decides not to reverse that policy action and, instead, leaves the money supply at its new, higher level permanently. a. Given that the Federal Reserve does not reverse its initial policy action, how will the economy move from the short-run equilibrium you described in question 7, above, to a new long-run equilibrium: through a shift in the aggregate demand curve, through a shift in the short-run aggregate supply curve, or through a shift in the long-run aggregate supply curve? (Note: focusing now just on the transition from the short run to the long run, only one of these curves will shift.) b. In which direction will the curve you mentioned above shift: to the left or to the right? C. Compared to its level in the initial long-run equilibrium, will the economywide level of prices in the new long-run equilibrium be higher, lower, or the same? d. Compared to its level in the initial long-run equilibrium, will real GDP in the new long-run equilibrium be higher, lower, or the same