final-f2003

final-f2003 - Final exam questions, fall 2003 PART I....

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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 short-run 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 supply-side 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
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Page 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 long-run 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 lump-sum 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.
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final-f2003 - Final exam questions, fall 2003 PART I....

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