14.02 - Fall 2001
Problem Set 8 Solutions
Posted November 30, 2001
I. True/False (30 points, 5 each)
1. TRUE, a decrease in the price of oil is re
f
ected in a reduction of the
mark-up
μ
(the interpretation story described in your text book). The natural
rate of unemployment declines, the natural level of output increases, so the AS
shifts to the right, and in the medium run the price level is lower. Thus, for a
F
xed nominal supply of money, the real money supply will increase, which will
result in a lower interest rate.
2. TRUE, the two policies have o
f
setting e
f
ects on output but both reduce
the interest rate (they are usually implemented to change the mix of private
vs government investments). If the AD shifts to the left because the monetary
authority miscalculates the increase in
M
(so we have an excessive monetary
contraction), then in the medium run the price level will be lower which further
reduces the interest rate.
3. TRUE, more competition in the goods market reduces the mark-up, and
the analysis become analogous to question 1.
4. TRUE, let
u
true
n
>u
estimated
n
and
π
i
t
−
π
t
−
1
=
−
α
(
u
t
−
u
i
n
)
, then the
authority trying to equate
u
t
with
u
estimated
n
will let
∆
π
be larger than necessary.
5. TRUE, as long
u
t
is larger than
u
n
,wehaveanega
t
ivechangeinthe
in
f
ation rate (ie, in
f
ation is decreasing while the unemployment rate is above its
natural rate, with the decrease being smaller the closer
u
t
is to
u
n
), but as soon
as
u
t
<u
n
then you expect to see the change in in
f
ation to become positive.
Therefore,
∆
π
increases over time. —Of course, if you assumed (and stated) that
we were talking about the
absolute value
of the change in in
f
ation, then your
answer would have to be FALSE, since the magnitude of
∆
π
will decrease (as
long as it is negative) only to start increasing again (once it becomes positive).