Practice MT3 Spring 2011

Practice MT3 Spring 2011 - Practice Questions for Midterm...

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Practice Questions for Midterm 3, Spring 2011 Part 1: Short Answer Problems Page 1
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1. (_____ of 16 points) Assume that labor supply is NOT interest elastic . For each of the following shocks, select whether the shock could be a source of output fluctuations, and indicate whether output would increase or decrease in response to it. Use the sketch of the general equilibrium graph to show how the shock would affect the IS/FE/LM curves (include both the exogenous and the endogenous shifts). Label the curves, show which one shifts and how, and mark the new general equilibrium point. Assume throughout that prices adjust quickly and Ricardian equivalence holds. Page 2 Yes No rise fall a) (4 points) Increase in current TFP  r Y b) (4 points) Decrease in government expenditures accompanied by a decrease in borrowing r Y c) (4 points) Increase in current money supply which also signals an increase in future money growth (NOT ELIGIBLE for next question) r Y Will output respond to the shock?
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2. (_____ of 21 points) Choose ONE of the shocks from the previous question EXCEPT if the shock description says it is not eligible to be chosen for the next question. Assume now that labor supply is interest elastic . Continue to assume that prices adjust quickly and Ricardian equivalence holds. Work out in detail what the effect of that shock is for the economy. Show how each market responds, and explain in words how equilibrium is attained. Label everything carefully, and at the end summarize your findings. Make sure you indicate which shock you chose . Structure your answer in the following steps: a. (_____ of 5 points) Draw the initial equilibrium of the economy using the graphs of the labor market, goods market, the money market, and the general equilibrium of the economy. Use the notation 111 , , , etc.  rYP to mark the initial equilibrium values of – income – the real interest rate – employment – real wages – investment – real money balances – the price level. Mark the initial ( STEP 1 ) shifts due to the shock in the three separate markets. Use a different color or line style, and a clear notation. Make sure you label your graphs very carefully. Explain in words what the initial shift(s) is (are). b. (_____ of 3 points) Draw your general equilibrium graph and illustrate the initial equilibrium. Now draw the shifts in the general equilibrium graph. Make sure that the connection between the initial ( STEP 1 ) shifts of the three markets and the shifts in the general equilibrium graph is clear. Again, use a distinctive line color or style, and a clear notation. Mark the new general equilibrium values of the real interest rate and income with 22 and rY . Explain (in words) what happens to the LM curve and the price level. c. (_____ of 4 points) Now return to the graphs of the three markets. Redraw these for the purpose of separately illustrating STEP 4 . Illustrate the endogenous shifts due to the changes in r , Y and P . Show the new equilibrium situation in each of the three markets.
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Practice MT3 Spring 2011 - Practice Questions for Midterm...

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