Midterm Exam Econ 2450, Section M
7 April 2009
Department of Economics
York University
Note: unless otherwise explicitly stated, for full mark you must show how you arrived at
your answer.
1. The IS*-LM* Model [4 marks]
Consider the IS*-LM* model, which describes a small open economy. The exchange rate,
denoted e, is the amount of foreign currency, say =Y (Japanese yen), that one must pay to
buy one unit of the domestic currency, say $. Let P be fhe price of foreign goods, and
P the price of domestic goods, and let ▯ be the spending share on domestic goods in the
d
consumption basket of the typical consumer in the domestic country, and 1▯▯ the spending
share on foreign goods, where 0 < ▯ < 1. To the domestic consumer the price of a foreign
good in terms of the domestic currency is P =f. Thus, the general price level in $ in the
domestic country, P, is given by
P
P = ▯P d (1 ▯ ▯) f.
e
The domestic interest rate is
xed and equal to the exogenous world interest rate, r . Demand
▯
for real money balances is given by L(r ;Y ), where:
@L(r ;Y )
> 0.
@Y
▯
The equation for the LM* curve is M=P = L(r ;Y ), that is:
M
P = L(r ;Y ).
▯P d (1 ▯ ▯) ef
(a) Draw the LM* curve in a diagram with e on the vertical axis and Y on the horizontal
axis. [2 marks]
(b) In the same type of diagram that you used under (a), show how the LM* curve shifts
in a response to an increase in M. [1 mark]
(c) The IS*-LM* model is known under what other name? (Hint: it is named after two
economists whose names started with M and F, respectively.) [1 mark]
For Problem 1 you do not need to motivate anything, just draw and state everything
correctly.
1 2. Labor markets I [4 marks]
Consider a model of the labor market. There are L workers who are endowed with one
unit of time each. There are N
rms, and AL is the output of a
rm that hires L workers,
where A > 0 and
2 (0;1). Here we let Y denote the output of each
rm, i.e., Y = AL .
(a) Draw a graph of Y = AL in a diagram with Y on the vertical axis and L on the
horizontal axis. [2 marks]
(b) Find an expression for the output of each
rm, Y , in a labor market equilibrium with
full employment. Your answer should be an equation which states that Y equals the product
of A and something involving N, L, and
. [Hint: there are L workers (all being employed)
and N
rms; all
rms are identical and hire equally many workers.] [2 marks]
3. Labor markets II [4 marks]
Consider a labor market model where there are M identical workers (or agents), each
with a unit time endowment. The workers care about consumption and leisure. There is no
saving, so they consume all their earnings. The utility of a worker who supplies an amount
of labor l (where 0 ▯ l

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