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MIT14_02S14_Exam2_S12_Sol - 14.02 QUIZ 2 Spring 2012 Time...

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1 14.02 QUIZ 2, Spring 2012 Time Allowed: 90 minutes Name (please print): Recitation time (please circle one): 9am, 10am, 11am, 1pm, 2pm, 3pm 1.Short Questions (7 points each): Determine whether each of the following statements is True, False or Uncertain. Give a brief explanation for each answer. a) 7pts. In an attempt to keep unemployment rate below its natural rate, many Latin American countries used expansionary fiscal and monetary policies heavily. These policy choices were the main reason why these same countries entered difficult periods of high inflation, from which they struggled to get out. True. By keeping u below u n , these countries slowly but firmly changed price expectations, and induced very high levels of inflation. By the time these countries realized they wanted to lower inflation, they had to resort to contractionary policies. Thus, they increased unemployment rate above u n so as to decrease inflation rate over time until it reached more manageable levels. b) 7pts. If the number of employed workers in a country decreases, the unemployment rate in the country will increase Uncertain / False. The unemployment rate is defined as Unemployment / (Employment + Unemployment). When the number of employed workers decreases, the number of unemployment may decrease at the same time if there are a large number of people quitting the labor force. If the decrease in the number of unemployment is sufficiently large, the unemployment rate will decrease. c) 7pts. An increase in the duration of unemployment should be linked to a decrease in flows in and out of unemployment, if one is to keep unemployment constant True. If the duration of unemployment is increasing, it can only be due to people entering unemployment, but not leaving as quickly as they used to (a decreased flow out of unemployment into either employment or out-of-labor-force). Holding every other flow constant, this would immediately increase unemployment. Therefore, if one is to keep unemployment constant, the lower flow out of employment must be accompanied be lower flow into employment. d) 7pts. Workers’ reluctance to take nominal pay cuts offers a feasible explanation of why the Phillips Curve relation breaks down when there is deflation. True. Workers are very likely to accept cuts in real wages that occur when their nominal wages increase more slowly than inflation. However, they are very likely to fight the same cut in real wages if it is done through cutting nominal wages while price level is decreasing more slowly. In these cases, the Phillips Curve relation between the change in inflation and unemployment may disappear when an economy is close to or below zero inflation.
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2 2. “Animal Spirits” (26 points)
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