202--ps.7-assignment - METU Department of Economics Econ...

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METU Department of Economics Econ 202 Macroeconomic Theory Instructors: Ebru Voyvoda - Şirin Saraçoğlu 2010-2011 Spring Semester Problem Set 7 The first three questions (with *) and any 4 of the true-false questions (question 7) are homework due on 12.05.2011, Thursday till 17:30. The remaining questions will be covered this week in the recitation hours. Question 1(*): A new source of energy has been discovered in Macronesia. This new technology will reduce the costs of production of macronesian firms, and as a consequence will reduce the mark-up of price over wage charged by firms. (The change in the mark-up is the only way in which the new technology affects the economy.) As the finance minister of Macronesia, you would like to analyze the impact of this shock on the economy. a) In the AS-AD set up, the reduction in production costs shifts which curve, the AS or the AD? How? Explain in words. b) What happens in the short-run? Show in a graph and describe the effect on the price and the level of output. c) What happens in the medium run? d) Describe the adjustment from the initial equilibrium towards the medium-run. Show in the graph. e) Compare the composition of spending (consumption, investment, and government spending) in the medium run with the initial pre-shock situation.
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Suppose now that after the initial discovery, you as finance minister would like to accelerate the transition to the medium run by using fiscal or monetary policies. f) What kind of policies would you recommend? Can you stabilize the economy to its new medium run equilibrium level of output and keep prices constant at the initial level? Show in a graph. g) Suppose that you achieved the objective in part (f) by changing government spending. What can you say about the new composition of spending (consumption, investment and government spending)? h) Compare the composition of spending (Y,C,I,G) and the interest rate in parts (c) and (g)
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Question 2 (*): Price Setting Relation: W = P e F (u,z) Wage Setting Relation: P = (1 + µ ) W Goods Market: Y = C(Y, T) + I(Y, i) + G Financial Market: M s = M d (Y, i ) P a) Find the aggregate supply relation. Describe the channel through which the AS curve slopes up/down. b) Assume that the economy is at a point such that the unemployment rate is equal to the
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This note was uploaded on 03/22/2012 for the course ECON 202 taught by Professor Tunc during the Spring '10 term at Middle East Technical University.

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202--ps.7-assignment - METU Department of Economics Econ...

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