Problem Set #7 (Fall 2006) 1/1Name: _______________________ SID: _______________________ Discussion Section: _______________________Problem Set #7Due Tuesday, December 5, 2006Problem Sets MUSTbe word-processed except for graphs and equations. QUESTIONS1.Suppose that rising inflation causes increased uncertainty which, in turn, motivates people to permanently increase their average propensity to save. Now suppose that the economy is at its NAIRU and there is a sudden increase in the price of oil. a.Based only on this information, use a DAD – SAS model diagram to clearlyshowthe effects of these events on equilibrium output and the inflation rate and during the first 2 years of the adjustment process. Also be sure to identifywhere the economy and inflation settle when the adjustment process is complete. b.Provide a briefeconomicexplanationfor what happened to economic output and inflation because of the events described above and during the first 2 years of the adjustment process. Also be sure to discusswhere economic output and inflation finally settle at the end of the adjustment process.
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