ECO202: Homework Assignment 4
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
a. At the medium run equilibrium, the rate of inflation is equal to the rate of nominal money
b. The sacrifice ratio is equal to 1/α and indicates the number of percentage points the
inflation increases for each percentage point unemployment increases by.
c. The unemployment rate will rise by only a small degree if the Central Bank can quickly
lower the inflation rate.
d. Assume that the economy begins at a medium-run equilibrium. The Central Bank begins
a disinflation process that will eventually cause inflation to fall permanently by 7
percentage points. The initial growth rate of the nominal money stock is 10%. True, False
or Uncertain: When the economy settles into the new medium-run equilibrium, the new
growth rate of the nominal money stock will be 5%.
e. The Egyptian economy is currently at a medium-run equilibrium, with an inflation rate of
13%. The Central Bank of Egypt would like to set an inflation target of 6%. Egypt’s
current growth rate of the nominal money stock is 18%. True, False or Uncertain: To
achieve and maintain the inflation target, the Central Bank of Egypt must keep the
growth rate of the nominal money stock equal to 6% when the Egyptian economy settles
into the medium-run equilibrium.
f. The Phillips curve says there is a direct relationship between the inflation and the
g. Suppose the price of raw materials used by firms increase, causing the mark-up rate to
increase from 15% to 30%. Also suppose that Phillip’s Curve is given by
P t P t 0.15 0.2 3u t, where the mark-up rate (μ) is entered into the equation as
decimal. True, False or Uncertain: As a result of the increase in firms’ mark-up rate, the
natural rate of unemployment will increase from 6% to 8%. Your explanation should be
supported by numerical evidence for your answer of true, false or uncertain.
h. Suppose Canada and the United States are both open economies using a flexible
exchange rate. Suppose that initially, Canada’s inflation rate is equal to 4% and the US
inflation rate is 5%. Both the Bank of Canada and the Federal Reserve Bank (the US
Central Bank) have promised to maintain these inflation rates forever. True, False or
Uncertain: To keep the real exchange rate fixed, the Bank of Canada should depreciate
the nominal exchange rate by 1% every year.
2. Suppose the following: Mexico’s economy consists of only one industry,
telecommunications industry, which is initially dominated by a monopolist named Carlos
Slim (according to Forbes, he’s the richest man in the world). The Mexican economy is
initially at a medium-run equilibrium in Year 1.
In the middle of Year 1, the Mexican Supreme Court passes a law that makes it illegal for a
monopoly to exist. The law essentially forces Mr. Slim to sell parts of his company to other
business owners. This introduces competition into to the telecommunications industry and
reduces Mr. Slim’s market power. Using 1) the labor market, 2) the IS-LM graph, 3) the AS-AD graph, illustrate the effect of
this law. You must provide an intuitive and theoretically-based explanation for why each of
the curves is shifting as well as for the direction of the shift.
3. Immediately after the financial crisis of 2008, the United States (US) government initiated a
temporary new program called the Emergency Unemployment Compensation (EUC)
program, with the purpose of adding to the existing unemployment insurance benefits paid to
unemployed workers (Unemployment Insurance is the US version of Canada’s EI). Because
of the EUC, unemployed individuals in some states could receive up to 73 weeks of
unemployment insurance benefits. Prior to the EUC program, the unemployed received only
26 weeks of benefits.
The EUC program expired in December 2013. This meant that overnight (literally), some
workers no longer qualified for unemployment insurance benefits because they already
received more than 26 weeks of benefits. Of those that continued to qualify, they experienced
a drastic cut in the number of weeks they would continue receiving benefits.
Assume that the economy is at a medium-run equilibrium before December 2013. Using the
labor market graph, the IS-LM graph, and the AS-AD graph, illustrate how the expiration of
the EUC in December 2013 impacted the US economy and the adjustments necessary to
reach the medium-run equilibrium in the space below. On the next page, you must provide a
theory-based and dynamic explanation for why specific curves are shifting and the direction
of the shift.
4. Suppose the Central Bank is currently at a medium-run equilibrium, but wants to decrease
inflation by 12 percentage points, from 16% to 4%, in 4 years. As a firm believer in the
traditional approach of reducing inflation, describe the policy you would recommend by
filling in the table below. To fill in the table, calculate the target path of inflation, the path of
unemployment, the path of output growth and the nominal money growth assuming that α =
0.5 (from Phillips Curve) and β = 0.75 (from Okun’s Law). You should show your work or
provide an explanation for how you derived the numbers in your answer.
Before Disinflation Process After
0 1 2 3 4 5 6 7
Inflation (%) 16
Unemployment Rate (%) 5
Output Growth (%) 3
Nominal Money Growth (%) 19
5. Suppose you’ve been given the following information. The Bank of Canada is trying to lower
the inflation rate by 12 percentage points. They are considering the timing of which to
accomplish this goal and have asked you to consider various time periods to complete the
goal. Complete the following tasks. You may continue on the other side of the page if
necessary. 1) In the table below, determine the unemployment rate required in each year, for each of
the policy options. The natural rate of unemployment is 10% and that the value of α is
equal to ¼. Answers without work will not receive credit.
2) Given your calculations, which policy would be more appropriate for Canada, a policy
that takes place in a shorter period of time or a longer period? Why?
Length of Rate for Each Year
Policy the Policy is In
6. The Bank of England is concerned that their inflation rate is too low and wants to
permanently raise the current inflation rate by 9 percentage points. The economy is currently
(period 0) at a medium-run equilibrium, and they want to achieve the process over a 3-year
Before Disinflation Process After
0 1 2 3 4
Inflation (%) 2    
Unemployment Rate (%) 7 2   
Output Growth (%) 4 24   
Nominal Money Growth (%)     
a. Using the information provided to you i