This preview shows pages 1–3. Sign up to view the full content.
Page 1
Final exam questions, fall 2003
PART I.
QUESTIONS FROM THE LAST SECTION OF THE
COURSE
(71 points total; about 1 hr total)
Question 1 (20 points; 18 minutes)
Suppose the following equations describe the shortrun
economy.
C = 500 + 0.8Y
D
T = 500 + 0.10Y
I = 400  300r
G = 600
GX = 500  100r
IM = 0.12Y
A)
(7 points)
Solve for the IS equation, which expresses Y as a function of the real interest rate,
r.
Show your work or no points.
B)
(7 points) Suppose the Fed follows a Taylor rule.
Describe the economic logic that makes
the Fed believe that increasing the real interest rate is an effective way to fight inflation.
Suppose the Fed follows a simple Taylor rule,
r = r* +
N
O
(
B
–
B
N
), where r* = 2 percent (use 0.02),
N
O
= 3 (use 3), and the target inflation rate is 2 percent (use 0.02).
C)
(3 points) If the actual inflation rate is 2 percent (use 0.02), what is the equilibrium value of
income?
Show your work or no points.
D)
(3 points) Suppose instead that the actual inflation rate is 5 percent.
In this case, what will
income be?
Show your work or no points.
Question 2 (10 points; 8 minutes)
The Phillips Curve captures the supplyside relationship between inflation and unemployment in the
short run
.
Suppose that initially the expected rate of inflation is 2 percent and the natural rate of
unemployment is 6 percent.
A)
(2 points) Using the axes at right, draw
the Phillips Curve.
Label the curve PC
A
.
Label your axes, and label one point on
the Phillips Curve.
B)
(4 points) Suppose the expected inflation
rate rises from 2 percent to 6 percent.
Draw the new Phillips Curve and label it
PC
B
. What effect does this rise have on
the Phillips Curve?
Why?
C)
(4 points) Suppose the natural rate of
unemployment falls from 6 percent to 4
percent.
Draw the new Phillips Curve
This preview has intentionally blurred sections. Sign up to view the full version.
View Full DocumentPage 2
and label it PC
C
. What effect does this fall have on the Phillips Curve?
Why?
Question 3 (25 points; 23 minutes)
Suppose that the economy is initially in equilibrium in the short run
with the actual unemployment
rate, u
1
, equal to the natural rate of unemployment (u*) and also equal to the unemployment rate (u
0
)
that is generated when the Fed sets the real interest rate, r, equal to the Fed’s notion of its longrun
normal rate, r*.
In addition, the actual inflation rate
B
1
is equal to the Fed’s target inflation rate (
B
N
)
which also equals the expected inflation rate (
B
e
).
Suppose the Fed follows a simple Taylor rule
when setting its interest rate target.
Suppose expectations are static.
A)
(3 points) Using the graph at the right, label the
axes, curves, and point depicting this initial
equilibrium.
B)
(4 points) Suppose the federal government
implements a lumpsum tax cut
by reducing
every family’s income tax bill by $400 per
child in the family.
What is the effect on the
inflation and unemployment rates?
Draw a
new graph at right to supplement your
answer.
This is the end of the preview. Sign up
to
access the rest of the document.
 Fall '08
 Wood

Click to edit the document details