Question # 2 (55 points] In this exercise you are asked to compare the effects on the long-run equilibrium of the economy of two types of changes in productivity: a change in current TFP (A) and a change in future expected higher TFP (A). 1 Part 2a. [15 points) According to some neoclassical economists, temporary shocks to current TPF (A) play an important role in giving rise to changes in output, employment, wages, interest rates and the level of prices. Consider the graphs of the labor, goods, and money markets and use them to illustrate the effect of a temporary increase in current TFP (total factor productivity) on the long-run equilibrium level of full-employment (N), real wages (W), potential output (7), the real interest rate (), and the price level (7). Explain briefly. Part 2b. (10 points) Suppose that the government seeks to prevent the price level from changing in response to the temporary productivity shock you discussed in Part 2a. In order to keep from adjusting, would it have to expand or contract the money supply? Illustrate your reasoning using a new graph of the money market with the price level P on the y-axis and the nominal quantity of money Mon the x-axis. Explain briefly. Part 2c. [15 points) Differently from the neoclassical economists in Part 2a, according to J.M. Keynes, shocks to the expected future marginal product of capital MPK due to expectations about future total factor productivity A' play an important role in giving rise to changes in output, employment, wages, interest rates and the level of prices. Consider the graphs of the labor, goods, and money markets and use them to illustrate the effect of an increase in MPK on the long-run equilibrium level of full-employment (N), real wages (w), potential output (7), the real interest rate (), and the price level (I). For this question assume that the increase in MPK has no effect on labor supply. Explain briefly Part 2d. [15 points] Suppose that the government seeks to prevent the price level from changing in response to the shock in Part 2c. In order to keep from adjusting, would it have to expand or contract the money supply? Illustrate your reasoning using a new graph of the money market with the price level on the y-axis and the nominal quantity of money M on the x-axis. Explain briefly and compare your reasoning in this scenario to the one in Part 2b. Question # 2 (55 points] In this exercise you are asked to compare the effects on the long-run equilibrium of the economy of two types of changes in productivity: a change in current TFP (A) and a change in future expected higher TFP (A). 1 Part 2a. [15 points) According to some neoclassical economists, temporary shocks to current TPF (A) play an important role in giving rise to changes in output, employment, wages, interest rates and the level of prices. Consider the graphs of the labor, goods, and money markets and use them to illustrate the effect of a temporary increase in current TFP (total factor productivity) on the long-run equilibrium level of full-employment (N), real wages (W), potential output (7), the real interest rate (), and the price level (7). Explain briefly. Part 2b. (10 points) Suppose that the government seeks to prevent the price level from changing in response to the temporary productivity shock you discussed in Part 2a. In order to keep from adjusting, would it have to expand or contract the money supply? Illustrate your reasoning using a new graph of the money market with the price level P on the y-axis and the nominal quantity of money Mon the x-axis. Explain briefly. Part 2c. [15 points) Differently from the neoclassical economists in Part 2a, according to J.M. Keynes, shocks to the expected future marginal product of capital MPK due to expectations about future total factor productivity A' play an important role in giving rise to changes in output, employment, wages, interest rates and the level of prices. Consider the graphs of the labor, goods, and money markets and use them to illustrate the effect of an increase in MPK on the long-run equilibrium level of full-employment (N), real wages (w), potential output (7), the real interest rate (), and the price level (I). For this question assume that the increase in MPK has no effect on labor supply. Explain briefly Part 2d. [15 points] Suppose that the government seeks to prevent the price level from changing in response to the shock in Part 2c. In order to keep from adjusting, would it have to expand or contract the money supply? Illustrate your reasoning using a new graph of the money market with the price level on the y-axis and the nominal quantity of money M on the x-axis. Explain briefly and compare your reasoning in this scenario to the one in Part 2b