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178.

200 Intermediate Macroeconomics


Tutorial (6)
Aggregate Supply

1
Multiple-Choice Questions
(2005 Exam Question)

1. The three models of the short-run aggregate


supply curve include all of the following
EXCEPT the:
b. sticky-wage model
c. sticky-price model
d. industry-misperception model
e. imperfect-information model
Answer: c.
Hint: (See P357).
2
Multiple-Choice Questions

2. The factor that is sticky-wage model is:


b. the real wage.
c. the nominal wage.
d. output.
e. inflation.
Answer: b.
Hint: (See P349).
3
Multiple-Choice Questions
(2005 Exam Question)

3. In the sticky-wage model, when GDP


increase and there are no supply shocks,
real wages:
b. rise.
c. fall.
d. remain constant.
e. may rise, fall, or remain constant.
Answer: b.
4
Multiple-Choice Questions
(2005 Exam Question)

4. The sticky-wage model predicts that:


b. the short-run aggregate supply curve is vertical.
c. the short-run aggregate supply is unrelated to
the price level.
d. firm move along a stationary labor demand
curve.
e. none of the above.
Answer: c.
Hint: (See P350).
5
Multiple-Choice Questions
(2005 Exam Question)
5. According to the imperfect-information model,
when prices unexpectedly rise, suppliers infer
that their relative price have _______, which
induces them to _______ output.
b. increased; increase
c. decreased; decrease
d. increased; decrease
e. decreased; increase
Answer: a.
Hint: (See PP352-353).
6
Multiple-Choice Questions

6. In the sticky-price model:


b. all firms adjust prices instantly in response to
changes in demand.
c. no firms adjust prices instantly in response to
changes in demand.
d. some firms adjust prices instantly in response to
changes in demand while others do not.
e. output is constant.
Answer: c.
7
Multiple-Choice Questions
(2005 Exam Question)

7. If all firms in the economy have fixed prices in the


short run:
b. the short-run and long-run aggregate supply
curves will be identical.
c. the short-run supply curve will be vertical.
d. the short-run supply curve will be horizontal.
e. none of the above will be true.
Answer: c.
8
Multiple-Choice Questions

8. The sticky-price model can explain why countries


with variable aggregate demand have short-run
aggregate supply curves that are:
b. flat.
c. steep.
d. horizontal.
e. vertical.
Answer: b.
Hint: (See P354).
9
Multiple-Choice Questions
(2005 Exam Question)

9. All three models of aggregate supply predict:


b. an upward-sloping SRAS curve.
c. a vertical LRAS curve.
d. that the actual level of output is equal to its
natural rate in the long-run.
e. all of the above.
Answer: d.
Hint: (See P357).
10
Multiple-Choice Questions
(2005 Exam Question)

10. According to the Phillips curve, the


inflation rate depends on:
b. expected inflation.
c. the difference between the actual and
natural rates of unemployment.
d. supply shocks.
e. all of the above.
Answer: d.
11
Multiple-Choice Questions
(2005 Exam Question)

11. When unemployment is below the natural rate


and inflation rises, it characterized as:
b. demand-pull inflation.
c. cost-push inflation.
d. a supply shock.
e. stagflation.
Answer: a.
Hint: (See P362).
12
Multiple-Choice Questions
(2005 Exam Question)
12. Compared with the assumption of adaptive
expectations, the assumption of rational
expectations implies that the transition to the
new long-run equilibrium following a credible
change in monetary or fiscal policy will take:
b. less time.
c. more time.
d. the same amount of time.
e. any of the above.
Answer: a.
Hint: (See P367) 13
Multiple-Choice Questions
(2005 Exam Question)

13. The Philips curve immediately shifts upward


whenever:
b. inflation rises.
c. unemployment falls.
d. an adverse supply shock, such as an oil price
increase, occurs.
e. all of the above.
Answer: c.
Hint: (See P362).
14
Multiple-Choice Questions
14. A typical estimate of the sacrifice ratio is about
5. Thus, if the inflation rate were to be lowered
by 2 percentage points, the amount of one year’s
GDP we must give up is:
b. 2%.
c. 2.5%
d. 5%
e. 10%
Answer: d.
Hint: (See P367).
15
Multiple-Choice Questions

15. According to the hypothesis of unemployment


hysteresis, a prolonged recession will:
b. increase the natural rate of unemployment.
c. decrease the natural rate of unemployment.
d. have no effect on the natural rate of
unemployment.
e. never occur.
Answer: a.
Hint: (See P371).
16
Numerical Questions

(1) Assume the following model of the


economy, with the price level fixed at 1.0:
C = 0.8(Y-T) T = 1000
I = 800 – 20r G = 1000
L = 0.4Y – 40r M = 1200

17
Numerical Questions

i. Write a numerical formula for the IS


curve, showing Y as a function of r alone.
Answer:
Y=C+I+G
= 0.8(Y – 1000) + (800 – 20r) + 1000
IS: Y = 5000 – 100r

18
Numerical Questions

ii. Write a numerical formula for the LM


curve, showing Y as a function of r alone.
Answer:
M=L
1200/1 = 0.4Y – 40r
LM: Y = 3000 + 100r

19
Numerical Questions

iii. What are the equilibrium values of Y, r, (Y


– T), C, and I?
Answer:
From i and ii we have
Y = 5000 – 100r (1)

Y = 3000 + 100r (2)

20
Numerical Questions

(continued)
(2) – (2)
200r = 2000
r = 10
Bring r back to (1) or (2), then Y = 4000.
Y – T = 4000 – 1000 = 3000
C = 0.8 * 3000 = 2400
I = 800 – 20 * 10 = 600
21
Numerical Questions

iv. Assume that G


r
increase by 200. By
LM
how much will Y
increase? What is the E2
15
government purchases E1
multiplier? 10

IS2
IS1

4000 4500 Y
22
Numerical Questions

Answer:
G = 1000 + ΔG = 1000 + 200 = 1200
IS: Y = C + I + G = 6000 – 100r (3)
LM: Y = 3000 + 100r (4)
(3) – (4), then r = 3000/200 = 15
Bring r back to (3) or (4), Y = 4500
ΔY = 4500 – 4000 = 500
ΔY/ΔG = 500/200 = 2.5
23
Numerical Questions

v. Assume that G is back r


at its original level of LM1
1000, but M increases
by 200. By how much 10 LM2
will Y increases in?
7.5
What is the multiplier
for money supply?
IS

4000 4250 Y
24
Numerical Questions
Answer:
M = 1200 + ΔM = 1200 + 200 = 1400
LM: M = L
1400 = 0.4Y –40r
Y = 3500 + 100r (5)
IS: Y = 5000 – 100r (6)
(5) – (6), r = 1500/200 = 7.5
and then Y = 4250.
ΔY = 4250 – 4000 = 250.
ΔY/ΔM = 250/200 = 1.25
25
Numerical Questions

(2) Suppose the economy’s short-run


production equation is
y = 14 L − 0.04 L 2

The demand for labour equation is


Ld = 175 – 12.5(W/p),
and the labour supply equation is
Ls = 70 + 5(W/p).
26
Numerical Questions
a. Find labour market equilibrium when the price
level is 1.00 and 1.25.
Answer:
The equilibrium value of labour market exists
when Ld = Ls. Therefore,
175 – 12.5(W/1) = 70 + 5(W/1)
17.5W = 105
W = $6
Then L = 100.
We can use the same method to obtain W =
$7.50 and L = 100 when the price level is 1.25.
27
Numerical Questions
b. Find short-run output when there is labour
market equilibrium at price level 1.00 and
1.25.
Answer:
From (a) we can see that labour market
equilibrium is unaffected by the price level.
Thus, y = 14 L − 0.04 L 2

y = 14 × 100 − 0.04 ×10000 = 1000


28
Numerical Questions

(3) Question 3 on page 373.


Suppose that an economy has the Phillips
curve

π = π −1 − 0.5(u − 0.06)

29
Numerical Questions

a. What is the natural rate of unemployment?


Answer:
The natural rate of unemployment is the
rate at which the inflation rate does not
deviate from the expected inflation rate.
Therefore, π = π −1
-0.5(u – 0.06) = 0
u = 0.06 = 6%.
30
Numerical Questions

b. Graph the short-run π LRPC


and long-run
relationships between
inflation and 0.5
unemployment. π-1

SRPC

0.06 u
31
Numerical Questions

c. How much cyclical unemployment is


necessary to reduce inflation by 5%? Using
Okun’s law compute the sacrifice ratio.

32
Numerical Questions
LRPC1
Answer: π
LRPC2
When inflation falls by
5%, π-1
π − π −1 = −0.05
π − π −1 = 0.5(u − 0.06) π0

-0.05 = -0.5(u – 0.06)


u = 0.16 SRPC
0.06 0.16 u

33
Numerical Questions

(continued)
Δu = 0.16 – 0.06 = 10%
According to Okun’s law: 1% change in u
translates in to change of 2% in GDP.
Hence, Δu = 0.16 – 0.06 = 10% leading to
fall in GDP of 20%.
The sacrifice ratio is 20/5 = 4.
34
Numerical Questions
d. Inflation is running at 10%. The Fed wants to
reduce it to 5%. Give two scenarios that will
achieve that goal.
Answer:
3) Very high unemployment rate (e.g. 16%) for a
short period of time (e.g. 1 year).
4) A small amount of cyclical unemployment (e.g.
8%) spread out over a long period of time (e.g. 5
years).
Both plans will achieve the goal but at different
speed.
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