Problem 01.

2. Phillips Curve with bargaining power's impact on labor productivity. The labor market model and the consequent Phillips Curve that we developed in the lectures assumed constant labor productivity. The evidence suggests that labor productivity grows both in the medium and long run (we will focus on the long run in the next lectures). Let us develop a more realistic model that pertains to medium run to evaluate the impact on unemployment rate and real wage of the factors that determine the bargaining power of workers: minimum wage, employment protection legislation, unemployment benefits, collective bargaining, ease with which employers relocate jobs. Recall that all these are captured in what we call catch-all variable, z.

As before wage-setting equation is given by W =Pe(1??u+z) (1) Consider the following production function that links the number of workers (N) to (real) out- put/income (Y ) via the level of labor productivity (A):

Y = AN (2) It follows that A = Y/N, that is to say, A is output per worker.1 What is the number of workers needed for the production of unit output? If one workers produces A much output then unit output requires 1/A workers. It follows that the cost of production of unit output is W ? (1/A) = W/A where W is the nominal wage rate. Using this observation and by assuming ?You can handwrite or type answers in a Word document. ?Please submit your answers in class. 1Note that in the lecture we simply assumed that A is constant and equal to one. 1 that firms set prices by adding a mark-up on the wage-cost, we can write the price-setting equation as follows:

P =(1+m)W (3) A where m is the mark-up rate. As we suggested in the beginning, in the medium (and long) run, the labor productivity is not constant at all. Moreover it is very likely that it depends on the bargaining power of workers measured by variable z. Consider the following association between the labor productivity, A, and z:

A = 1 + 2z (4) Equation (4) suggests that the greater the bargaining power of workers the higher the level of labor productivity. Plugging A given by equation (4) into the price-setting equation given by equation (3) yields

P = 1+mW (5) 1+2z The nominal wage that is compatible with price-setting relation then is W = P (1 + 2z)/(1 + m). Substitute it for the nominal wage in equation (1) to get P(1 + 2z) = Pe(1 ? ?u + z) 1+m Rearranging it gives us the following equation:

P =Pe(1+m)(1??u+z) (6) (1+2z)

You are almost ready to draw some conclusions! Now do the parts below.

(a) Derive the Phillips curve using equation (6). (Hint: To start, transform actual and expected price levels to obtain actual and expected inflation.)2

(b) Derive the suggested (not so much) natural rate of unemployment (that is, the equilibrium rate of unemployment in the medium run).

(c) What is the real wage that corresponds to the (not so much) natural rate of unemployment.

(d) Suppose workers win a substantial increase in the minimum wage in the overall economy. What happens to their real wage? What happens to (not so much) natural rate of unem- ployment? Is their achievement self-defeating?

Problem 02.

The equation of exchange is an ________ while the quantity theory of money is a theory that ________.

Question 1 options:

A) accounting theory; assumes the price level is constant

B) accounting theory; economists use to explain changes in real GDP

C) accounting identity; assumes the money supply is constant

D) accounting identity; assumes velocity is held constant

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Question 2 (5 points)

Question 2 Unsaved

Suppose the actual federal funds rate is equal to the rate implied by a particular inflation goal. In this situation, the Taylor rule implies that

Question 2 options:

A) monetary policy is contractionary.

B) monetary policy will tend to produce that inflation rate.

C) fiscal policy will result in a balanced budget.

D) monetary policy is expansionary.

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Question 3 (5 points)

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The demand for money curve is drawn

Question 3 options:

A) holding several things constant, including GDP and interest rates.

B) with interest rates on the vertical axis and the curve sloping down since lower interest rates mean the "price" of holding money has fallen.

C) with interest rates on the horizontal axis, and the curve sloping up since the "price" of holding money varies directly with the interest rate.

D) holding several things constant, including the price level and interest rates.

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Question 4 (5 points)

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If the Fed has announced that it plans on increasing the interest rate it will

Question 4 options:

A) engage in expansionary open market operations, thereby increasing the money supply.

B) engage in contractionary open market operations, thereby increasing the money supply.

C) engage in contractionary open market operations, thereby decreasing the money supply.

D) engage in expansionary open market operations, thereby decreasing the money supply.

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Question 5 (5 points)

Question 5 Unsaved

Suppose the economy currently has an inflationary gap. The Fed engages in contractionary monetary policy. The impact of contractionary monetary policy will be to

Question 5 options:

A) increase short-run aggregate supply, decrease in prices and decrease in real GDP.

B) increase short-run aggregate supply, decrease prices and increase real GDP.

C) decrease aggregate demand, decrease prices, and increase real GDP.

D) decrease aggregate demand, decrease prices, and decrease real GDP.

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Question 6 (5 points)

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Refer to the above figure. Suppose point A is the original equilibrium. If there is an increase in the money supply, the new long-run equilibrium is given by point

Question 6 options:

A) D.

B) A.

C) B.

D) C.

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Question 7 (5 points)

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Which of the following will NOT occur in the short run when the money supply decreases?

Question 7 options:

A) The price level decreases.

B) The interest rate will increase.

C) Aggregate supply decreases.

D) People will buy fewer goods and services.

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Question 8 (5 points)

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Holding money as a medium of exchange to make payments is

Question 8 options:

A) the capital demand for money.

B) the precautionary demand for money.

C) the transactions demand for money.

D) the asset demand for money.

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Question 9 (5 points)

Question 9 Unsaved

A key causal link in the interest-rate-based transmission mechanism for monetary policy is from

Question 9 options:

A) real GDP to investment.

B) investment to the interest rate.

C) a monetary policy action to excess reserves.

D) the money supply to excess reserves.

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Question 10 (5 points)

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The number of times per year that a dollar is spent on final goods and services defines

Question 10 options:

A) the price index.

B) GDP.

C) the income velocity of money.

D) the money supply.

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Question 11 (5 points)

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Suppose that the Fed has decided to utilize the Taylor rule to implement monetary policy. If the actual federal funds rate target is presently below the level specified by the Taylor rule and has been lower then this level for several weeks, then this would be a signal that

Question 11 options:

A) monetary policy is very expansionary.

B) monetary policy is very contractionary.

C) the Fed should switch to targeting the money supply instead of the federal funds rate.

D) the Fed should halt efforts to target the money supply.

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Question 12 (5 points)

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The interest-rate-based monetary policy transmission mechanism emphasizes the

Question 12 options:

A) indirect effect of a change in the money supply that operates via a change in total planned expenditures generated by a change in the interest rate.

B) direct effect of a change in the money supply that operates via a change in total planned expenditures generated by a change in the interest rate.

C) direct effect of a change in the money supply that operates via a change in total planned production generated by a change in the price level.

D) indirect effect of a change in the money supply that operates via a change in total planned production generated by a change in the price level.

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Question 13 (5 points)

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Suppose the Fed increases the money supply. As a result of this, people deposit excess funds into their bank accounts, causing banks to have excess reserves. As a result, the banks lower the interest rates that they charge on loans, and investment rises, causing an increase in aggregate spending. This is known as a(n)

Question 13 options:

A) direct effect of fiscal policy.

B) indirect effect of monetary policy.

C) direct effect of monetary policy.

D) indirect effect of fiscal policy.

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Question 14 (5 points)

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Which of the following is a TRUE statement about the relationship between the price of bonds and the interest rate?

Question 14 options:

A) The prices of bonds are inversely related to the interest rate.

B) The prices of bonds are unrelated to the interest rate.

C) The prices of bonds increase when the interest rates rise.

D) The prices of bonds are directly related to the interest rate.

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Question 15 (5 points)

Question 15 Unsaved

Suppose the actual federal funds rate is above the rate implied by a particular inflation goal. In this situation, the Taylor rule implies that

Question 15 options:

A) monetary policy is expansionary.

B) monetary policy is contractionary.

C) monetary policy is Neither expansionary or contractionary.

D) fiscal policy is expansionary.

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Question 16 (5 points)

Question 16 Unsaved

Suppose the typical household holds $1,000 when the interest rate is 5 percent. When the interest rate rises to 6 percent, the typical household would most likely hold

Question 16 options:

A) less money because the opportunity cost of holding money is higher.

B) more money because the opportunity cost of holding money is higher.

C) more money because the opportunity cost of holding money is lower.

D) less money because the opportunity cost of holding money is lower.

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Question 17 (5 points)

Question 17 Unsaved

The transactions demand for money is the demand to hold money to

Question 17 options:

A) make regular, expected purchases.

B) purchase bonds when interest rates increase.

C) meet unplanned expenditures.

D) store one's wealth.

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Question 18 (5 points)

Question 18 Unsaved

Suppose there is an increase in the money supply, but that people's demand for money balances increases by a greater amount at the same time. The net effect would be

Question 18 options:

A) an increase in aggregate demand due to the increase in the money supply, but a decrease in aggregate supply due to the increase in the demand for money.

B) a lower price level in the long run.

C) lower interest rates, greater real GDP, and a higher price level as aggregate demand increases because of the indirect effect of the increase in the money supply.

D) no change in aggregate demand or aggregate supply.

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Question 19 (5 points)

Question 19 Unsaved

The Trading Desk's open market operations

Question 19 options:

A) occur throughout each day.

B) occur once a week.

C) are confined within a six-hour interval each weekday morning.

D) are confined within a one-hour interval each weekday morning.

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Question 20 (5 points)

Question 20 Unsaved

When the Fed purchases federal government bonds in the open market

Question 20 options:

A) there is no change in the money supply.

B) the money supply expands.

C) the demand for money expands.

D) the money supply contracts.

Part B.

plain how this development affects the interest rate, output, and investment. 2 The following questions deal with the medium-run correction in a closed economy after it is perturbed by a negative shock. (a) Combine the Phillips Curve (PC) equation 7 -7 = m+z-au with the production function Y = N to obtain the following alternative expression for the PC. IT - Te = ( Y - Yn) In your answer briefly define the variables used in the above relations. Suppose that the economy is initially in a medium-run equilibrium, in which the actual and expected inflation rates are 2% and inflation expectations are anchored at 7 = 2%, but then, due to a fall in business confidence, investment spending significantly falls. In parts (b), (c) and (d) below explain in words and illustrate using both the IS-LM model and the PC. (b) Describe the impact of the fall in business confidence in the short run. How does the short- run equilibrium output and inflation rate compare to the initial medium-run equilibrium output and inflation rate if the central bank does not change the real policy rate? MATHOO02 5 TURN OVER (c) Describe the medium run correction process. Be sure to discuss the change in output, inflation and interest rate. (d) In the course of the medium run correction, does the economy face the possibility of running into a liquidity trap? If so, propose alternative policies to get the economy out of the liquidity trap