# ps3_answers - 14.02 Principles of Macroeconomics Problem...

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14.02 Principles of Macroeconomics Problem Set #3 - Answers October 16, 2002 1 PART I. True, False, Uncertain 1 Workers like in f ation since it raises their wages. False: Workers only care about real wages (W/P) and not about the nominal level of wages which presumably increases with in f ation. 2 Improvements in health that increase the elderly population tend to increase the unemployment rate. False: An increase in the amount of elderly in the population won’t increase thelaborforceandtheamoun to fpeop lelook ingforjobs . Theag ingprocess would decrease the participation rate but need not imply an increase in the unemployment rate. 3 If the government increases G without altering the supply of money, the amount of money demanded in equilibrium varies since both Y and i change. False: An increase in G tends to expand the level of output and then the Md (Y ,i )sh i f t supinth e F nancial market graph. Nevertheless, the amount on money demanded in equilibrium has to be equal to the supply of money, which did not change. To restore the equilibrium, the interest rate goes up compensating the positive e f ect of the higher income in the money demand. In equilibrium, the amount of money demanded is exactly equal to the F xed supply of money. 4 A monetary contraction cannot a f ect the public budget since it is not a F scal policy. False: A monetary contraction tends to increase the interest rate (it shifts the LM curve to the left). The demand for investment decreases and the equilibrium level of output is smaller. If part of the government revenues were collected with proportional income tax, the total amount of public revenues will decrease and the public budget will be a f ected. 1

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5 As in microeconomics, the AS curve is upward slopping because producers sell more goods when the price is high. False: The AS curve is upward sloping because a higher output level is equivalent to a lower unemployment rate. A lower unemployment rate gives the worker higher bargaining power in the wage setting process and the level of prices increases on wage (with the same simplifying assumptions used in the book, the level of prices is proportional to the wage). 2 PART II. IS-LM model Suppose the population in the economy is divided into two groups. Although the two groups have equal amount of people, the richer one (Group A) gets 70% of total income and the poorer one (Group B) gets the remaining 30%. The economy is represented by the following equations. M d =5 Y 120 r M s = 10000 I = 296 20 i +0 . 1 Y C A = 120 + c A ( Y A T A ) C B =60+ c B ( Y B T B ) G = 500 1. Assuming c A = c B = 0 . 6 and T A = T B = 200 ,der ivetheISandLM curve and f nd the equilibrium level of output and interest rate and compute the f scal budget. Use graphs and math.
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ps3_answers - 14.02 Principles of Macroeconomics Problem...

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