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1 Name: ______ ANSWERS ______ (Last name, first name) SID: _____________________ Lecture (1 or 2): _____________________ UGBA 101B Macroeconomic Analysis for Business Decisions Dr. Steven Wood Spring 2003 EXAM #3 Please sign the following oath: The answers on this test are entirely my own work. I neither gave nor received any aid while taking this test. I will not discuss the questions on this test until after 5:00 p.m. on April 15, 2003. ______________________ Signature Any test turned in without a signature indicating that you have taken this oath will be assigned a grade of zero. Graph Instructions When drawing diagrams, the following rules apply: a. Completely, clearly and accurately label all axis, lines, curves, and equilibrium points. b. The original diagram and equilibrium points must be drawn in black. c. The first shift of any line and the new equilibrium points must be drawn in red. d. Any subsequent shifts in curves and new equilibrium points must be drawn in another color, preferably blue or green. Do NOT open this test until instructed to do so.

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1. DAD – SAS Model. Assume that the economy is initially at Yn with a steady inflation rate. For each of the following scenarios, use a DAD-SAS model to clearly show and provide a brief economic explanation of what is happening to the output ratio and inflation during the first 3 years of the adjustment process (i.e., years 1, 2, and 3). Also, clearly show where the economy will be after long-term equilibrium is re-established. (20 points.) a. After the invention of a new high-speed computer chip, business firms decide to significantly upgrade their computer networks. In year 1, an increase in autonomous I shifts the DAD curve to DAD1 and increases Y-hat to Y-hat1. Inflation stays at p-dot0 because Y-hat0 = 0. In year 2, the SAS curve shifts up to SAS2, increasing inflation to p-dot2 because Y- hat1 > 0. Higher inflation reduces the real Ms, shifting the LM curve left, raising r, crowding out some interest-sensitive spending, particularly I, which reduces Y-hat to Y-hat2. Nevertheless, Y-hat2 > 0. In year 3, the SAS curve shifts up to SAS 3, increasing inflation to p-dot3 because Y- hat2 > 0. The rise in inflation will be less than in year 2 because Y-hat2 < Y-hat1. Higher inflation reduces the real Ms, shifting the LM curve left, raising r, crowding out interest-sensitive spending, particularly I, which reduces Y-hat to Y-hat3. Although Y-hat3 < Y-hat 2, Y-hat3 > 0. This process continues in smaller and smaller steps until the SAS curve has shifted up to SASn, inflation has increased to p-dotn and Y-hat has fallen back to Y-hatn. Long- run equilibrium is re-established at Y-hatn = Y-hat0 and p-dotn > p-dot0. Y0
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