FINAL EXAMINATION (Spring 2003)
Question 2 (14 points total; 12 minutes total)
The MPRF/PC model captures changes in the unemployment and inflation rates in the
short run when prices may be sticky. Suppose the central bank follows a rule that sets
monetary policy in reaction to changes in the inflation rate.
A) (8 points) On the demandside of the economy, an increase in the inflation rate is
associated with an increase in the unemployment rate. Explain why. (That is, explain why
the MPRF slopes up.)
B) (6 points) On the supplyside of the economy, an increase in the inflation rate is
associated with a decrease in the unemployment rate. Explain why. (That is, explain why
the PC slopes down.)
Question 3 (10 points total; 9 minutes total)
A) (5 points) Suppose that the advent of desktop publishing lowers menu costs. What
effect does this change have on the Phillips Curve? Why? Using the axes at the right, draw
the original Phillips Curve (PC1) and the new Phillips Curve (PC2). Label your axes.
B) (5 points) Suppose instead that the productivity growth rate increases. What effect
does this change have on the Phillips Curve? Why? Using the axes at the right, draw the
original Phillips Curve (PC1) and the new Phillips Curve (PC2). Label your axes.
Question 4 (12 points total; 9 minutes total)
A) (2 points) In 1 or 2 sentences, explain what it means for the Fed to follow the simple
Taylor rule:
B) (5 points) Suppose the Fed follows the simple Taylor rule:
. Suppose now the marginal propensity to consume, Cy,
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increases. Does the slope of the MPRF become steeper, flatter, or stay the same? Explain
why. Supplement your answer with a graph.
C) (5 points) Suppose the Fed follows the simple Taylor rule:
. Suppose a new Fed chairman is elected, and he dislikes
inflation less than the previous chairman did. Does the slope of the MPRF become steeper,
flatter, or stay the same? Explain why. Supplement your answer with a graph.
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 Fall '08
 Wood
 Inflation, Monetary Policy, Unemployment, Great Depression, Fed, tax cut

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