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ECO202Y5 Quiz: HW3 - Fixed ER SR Open economy, Medium Run Economy

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Kathleen Wong

ECO202: Homework Assignment 3 1. True/False/Uncertain. Read the statements carefully. Decide whether the statement is true, false or uncertain. Explain your answer. Answers without an explanation will not receive credit. a. The number of workers leaving employment is the same number of workers leaving the labor force. b. It may be in the best interests of employers to pay wages higher than their workers’ reservation wage. c. Both workers’ and firms’ bargaining power decrease as unemployment rates in the labor market increase. d. The natural rate of unemployment is constant. e. The natural rate of unemployment is affected by shocks to the labor, money or goods market. f. The AS curve will shift when there are changes to the mark-up rate, the catch-all variable or price expectations. g. The AS curve is derived by combining the IS and LM equations. h. Until another shock occurs, an economy will remain at the medium-run equilibrium once there. i. Denmark’s currency, the Danish Krone (DKK) is pegged to the Euro (EUR) at the following exchanged rate: 7.5 DKK = 1 EUR. As one of the largest economies in the Eurozone, Germany’s policies have a large impact on influencing the Euro. True, False or Uncertain: When Germany engages in contractionary fiscal policy, Denmark will have to decrease their money supply, which will cause them to move up and along the interest parity curve. j. Economic shocks that shift the AD curve are considered neutral because the economy returns to the original natural level of output. k. You must show your work for this question to receive full credit. Use the table below to help you decide if the following statement is true, false or uncertain: Ontario has an 84% employment rate. (see table on page 2) l. The February 6 , 2015 edition of the Economist includes an article about the US labor market, titled ‘America’s labor market: the end of the low-pay puzzle?’ Quoting directly from the article: “The economy created more than one million additional jobs in the last three months, the strongest pace of job growth since 1997. In many states the unemployment rate is nearing lows of 3% but wages are barely rising. That’s not what you would expect…” True, False or Uncertain: The magazine’s conclusion that barely- rising wages are unexpected is theoretically supported by the price-setting equation. m. Due to their geographical proximity, Venezuela and Columbia trade heavily with one another. Suppose the Central Bank of Venezuelan has adopted a crawling peg for the Venezuelan Bolivar (VEF), choosing the Columbian Peso (COP) as the leader currency. As of December 2014, Venezuela’s inflation rate is 64%, whereas Columbia’s inflation rate is 4%. True, False or Uncertain: When Venezuela regularly devalues their currency by 50%, Venezuela will experience a trade surplus. Total Population in Ontario 25,000 # of people working in the wine industry 1,000 # of people working in the construction industry 2,000 # of scholars and teachers 500 # serving out prison sentences 1,500 # of retirees 2,000 # of stay-at-home parents raising children 2,500 # of students enrolled full-time in university 1,000 # of people working in service/finance sectors 1,000 # of children enrolled in grades 1 thru10 3,500 # of people in the agricultural/food industry 2,750 # serving in the Canadian Forces (navy, army, air force) 1,000 # of people in the maple syrup industry 1,250 # of commercial retailers 1,000 # of people currently without work, but seeking employment 2,000 # of aboriginals living on the First Nations Native Reserve 2,000 2. Suppose an economy in the medium run is given by the following equations: C = 500 + 0.5Y d M : (M – P) = 25 – P I = 200 + 0.3Y - 50i M : YL(i) = 100Y – 100i e G = 200 P e P + (Y – Y )n T = 200 P = 5 Y n 20 Note: we are taking (M – P) to be an approximation of (M/P). Aggregate supply is e e represented by P = P + (Y – Y )nwith the values for P and Y plngged in. a. Derive the IS curve with i as a function of Y. b. Derive the LM curve with i as a function of Y and P. c. Graphically derive the AD curve from the IS-LM curve. What is the economic interpretation of the AD curve? d. When does the AD curve shift? How is a change in P represented on the AD curve? How is it represented in the IS-LM graph? e. Derive the AD and AS curves. f. When does the AS curve shift? How is a change in P represented on the AS curve? How is a shift in the AS curve represented in the IS-LM graph? g. Solve for equilibrium P, Y and i. 3. Show in an IS-LM and AS-AD graph the effects of an increase in government spending. Next, using the same graph, show how the economy will transition back to the natural rate of unemployment. Explain intuitively how this transition takes place. 4. Show in an IS-LM and AS-AD graph the effects of a decrease in the price of oil. Using the same graph, illustrate the economy when it transitions to the medium-run equilibrium. What happens to the natural level of output? What happens to the price level? 5. Suppose that people expect higher future taxes due to the government’s current debt levels, which causes them to start saving more now for the future tax bill. What effect will this have on the economy? Illustrate this using an IS-LM and AS-AD graph, explaining the short run effects and how the economy will transition to the medium-run equilibrium. 6. Last year, England’s participation rate 75%. You’ve been provided with the following information about the citizens residing in Australia based on this year’s population census. True, False or Uncertain: This year’s participation rate is lower than last year’s participation rate. Total Population in England 35,000 # serving to protect the country (those serving in the army, marine
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