20072prbset6 - METU Department of Economics Econ 202...

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METU Department of Economics Econ 202 Macroeconomic Theory Instructors: Ebru Voyvoda and Şirin SaraçoğluTeaching Assistant: Gizem Koşar2007-2008 Spring Semester Problem Set 6 (OB Chapters 7 and 8) The questions marked with (*) are to be solved as homework due 18.04.2008 Question 1:Suppose a hypothetical economy has the following Phillips curve: ()etttnd uuwhere unis the natural level of unemployment, πtis the inflation rate at t, and πetis the expected inflation rate at t. a)Describe briefly what sign you expect on parameter d. Explain the economic significance of the sign. b)Assume d = -0.4, un = 0.08, and πet = 0.05 for all t. Graph the short run and long run Phillips curves. c)Now assume that πet= πt-1, so that inflation in the current period, t, depends on unemployment and the inflation of the last period, t-1. What is the non accelerating inflation rate of unemployment (NAIRU)? Explain the intuition behind the NAIRU. d)If the government of this hypothetical economy wants to reduce inflation by 4%, how much does the Phillips curve suggest unemployment will change? Calculate the number of point-years excess unemployment. With this goal, can the Central Bank affect the number of point-years of excess unemployment? Discuss. Do you think the Central Bank can choose the distribution of excess unemployment over time? Question 2(*):Assume that the following is true about the economy:C = 70 + 0.1(Y T) I = 40 − 200i + 0.1Y G = 100 T = 100 Md=$Y(0.4 − i) Ms= 80 Assume the following wage setting relation: W = Pe(z − 30u) where z = 14013is a parameter that represents the workers bargaining power and u is the unemployment rate. The following is the price setting relation P = (1+ μ)W where μ = 0.3 is the markup.The economy production function is: Y = N The labor force is

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