METU
Department of Economics
Econ 202 Macroeconomic Theory
Instructors: Ebru Voyvoda and Şirin Saraçoğlu
Teaching Assistant: Gizem Koşar
20072008 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
t1
, so that inflation in the current period, t, depends on
unemployment and the inflation of the last period, t1. 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 pointyears excess unemployment. With this goal, can the Central
Bank affect the number of pointyears 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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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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 Spring '10
 tunc
 Economics, Macroeconomics, Inflation, price level

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