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Econ 2450 midterm 2009

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ECON 2450
Nils- Petter Lagerlof

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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