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20072prbset6

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

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METU Department of Economics Econ 202 Macroeconomic Theory Instructors: Ebru Voyvoda and Şirin Saraçoğlu Teaching Assistant: Gizem Koşar 2007-2008 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: () e t t t n d u u  where u n is the natural level of unemployment, π t is the inflation rate at t, and π e t is 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, u n = 0.08, and π e t = 0.05 for all t. Graph the short run and long run Phillips curves. c) Now assume that π e t = π t-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 M d =\$Y(0.4 − i) M s = 80 Assume the following wage setting relation: W = P e (z − 30u) where z = 140 13 is 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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L = 300 a) Derive the AS relation and graph the AS curve. b) Derive the AD relation and graph the AD curve. c) Calculate and graph the medium run equilibrium.
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20072prbset6 - METU Department of Economics Econ 202...

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