14.02 Solutions Quiz II Spring 03

Transcription

1 Multipl Choic Qustions (30/100): Plas circl th corrct answr for ach of th multipl-choic qustions. In ach qustion, only on of th answrs is corrct. Each qustion counts 3 points. 1. Th natural rat of unmploymnt dpnds on all of th following xcpt: a) Th lvl of unmploymnt insuranc b) Th mark-up c) Th bargaining powr of workrs with firms d) Mony supply 2. In th AS-AD modl, a dficit rduction without montary accommodation lads to all of th following xcpt: a) A chang in th composition of output b) A rduction in th natural rat of unmploymnt c) A rduction in th pric lvl in th short run d) A rduction in th pric lvl in th mdium run 3. In th AS-AD modl, a supply shock such as an incras in th pric of oil lads to all of th following xcpt: a) A dcras of output in th short run b) An adjustmnt of xpctations to a lowr lvl of prics in th mdium run c) An incras of th intrst rat in th short run d) An incras of th intrst rat in th mdium run 4. Th aggrgat supply quation is a rlation that coms out of th pric-stting bhavior of firms and a) th wag-stting outcom of firms and workrs b) th Phillips curv c) Okun s law d) th supply of products to th forign markts 5. Fiscal policy has no ffct on th lvl of output in th mdium run unlss a) it affcts aggrgat dmand b) it changs th pric-xpctations of th agnts in th conomy c) it changs th way firms and workrs bargain ovr th wag d) it changs govrnmnt spnding togthr with taxs. 6. Th original Phillips curv is a rlation that capturs a trad-off btwn a) inflation and unmploymnt b) acclrating inflation and unmploymnt c) inflation and pric lvls d) output and acclrating unmploymnt ) output and pric lvls 1

2 7. Th original Phillips curv can b obtaind from a) th aggrgat supply quation and inflation xpctations st to zro b) th aggrgat dmand quation and inflation xpctations st qual to prvious priod inflation c) th aggrgat supply quation and inflation xpctations st qual to prvious priod inflation d) th aggrgat dmand quation and inflation xpctations st to zro 8. Th modifid Phillips curv tll us that th only way to rduc inflation is through a) unmploymnt rats highr than th natural rat b) xpansionary fiscal policy c) unmploymnt rats lowr than th natural rat d) contractionary fiscal policy 9. Stock prics incras if: a) Mony supply incrass, and this incras was anticipatd a long tim ago b) Th nominal intrst rat incrass unxpctdly c) It bcoms known that profits two yars from now will b highr than xpctd d) Th conomy ntrs a rcssion 10. Holding mony supply fixd, th impact of an unxpctd incras in govrnmnt spnding on th stock markt is a) An incras in stock prics, as output incrass unxpctdly in th short run b) A drop in stock prics, as intrst rats incras unxpctdly in th short run c) Ambiguous, as both th intrst rat and output incrass unxpctdly in th short run d) No ffct, as output is unaffctd in th mdium run 2

3 Long Qustion I (40/100): A nw sourc of nrgy has bn discovrd in Macronsia. This nw tchnology will rduc th costs of production of macronsian firms, and as a consqunc will rduc th mark-up of pric ovr wag chargd by firms. (Th chang in th mark-up is th only way in which th nw tchnology affcts th conomy.) As th financ ministr of Macronsia, you would lik to analyz th impact of this shock on th conomy. Answr th following qustions a) h), which count 5 points ach. a) In th AS-AD st up, th rduction in production costs shifts which curv, th AS or th AD? How? Explain in words. Answr: It affcts th AS only. For any output lvl, now th AS curv will rlat to a lowr pric lvl (AS shifts down in th Y-P diagram). b) What happns in th short-run? Show in a graph and dscrib th ffct on th pric and th lvl of output. Answr: P AS 0 AS 1 P 1 = P 0 P 1 Short-Run Eqm AD Y 0 Y 1 Y c) What happns in th mdium run? Answr: Prics dcras vn furthr and output rachs a nw highr natural lvl. 3

4 d) Dscrib th adjustmnt towards th mdium-run. Show in th graph. Answr: P AS 0 AS 1 AS MR P 1 = P 0 P 1 Mdium- Run Eqm AD Y 0 Y 1 Y n nw Y ) Compar th composition of spnding (consumption, invstmnt, and govrnmnt xpnding) in th mdium run with th initial pr-shock situation. Answr: Rcall Y=C(Y-T)+I(i,Y)+G In th nw quilibrium, G and T havn t changd. Y is highr, so C has also to b highr. Now w nd to s what happns to invstmnt. In th IS-LM diagram, P is dcrasing throughout th analysis, so M/P is incrasing. Th LM is thn moving continuously to th right. This in turn implis that th intrst rat is going down. In th mdium run w ar in quilibrium with a lowr pric lvl and a lowr intrst rat. So, as intrst rats wnt down and output wnt up; invstmnt wnt unambiguously up. So, in th mdium run quilibrium, C is highr, I is highr and G is th sam. Th intrst rat is lowr. 4

5 Suppos now that aftr th initial discovry, you as financ ministr would lik to acclrat th transition to th mdium run by using fiscal or montary policis. f) What kind of policis would you follow? Can you stabiliz th conomy to its nw mdium run quilibrium lvl of output and kp prics constant? Show in a graph and xplain. Answr: You would lik to xpand dmand - this could b don with xpansionary montary policy (incrasing M) or xpansionary fiscal policy (incrasing G or rducing T). P AS 0 AS 1 P 1 = P 0 = P 1 Expansiona ry policy Y 0 Y 1 Y n nw AD AD Y g) Suppos that you achivd th objctiv in part (f) by changing govrnmnt xpnding. What can you say about th nw composition of spnding (consumption, invstmnt and govrnmnt xpnding) and th intrst rat? Answr: Rcall Y=C(Y-T)+I(i,Y)+G Comparison with pr-shock quilibrium Output is highr in th mdium-run. Givn that T is constant, consumption C is highr. Now in th IS-LM diagram, prics do not mov (thy ar kpt constant by th xpansionary policy), and givn that M is constant, th LM dos not mov.. Howvr, G incrasd, so IS movs to th right. In quilibrium th intrst rat is now highr than th pr-shock quilibrium. Th ffct in invstmnt I is ambiguous. h) Compar th composition of spnding (Y,C,I,G) and th intrst rat in parts (c) and (g). Answr: Output in th mdium run is th sam. Consumption is th sam. G is obviously highr in part f than in part d. Invstmnt (I) is lowr in part f than in part d. Th intrst rat in part f is highr than in part d. 5

6 Long Qustion 2 (30/100): This qustion is about th dtrmination of stock prics. Imagin that w liv in a world with only 3 priods, t=1, t=2, and t=3. Us th following notation: Th xpctd nominal intrst rat btwn priod t and t+1 is dnotd i t Th xpctd ral intrst rat btwn priod t and t+1is dnotd r t Expctd inflation btwn priod t and t+1is dnotd π t Th xpctd nominal dividnd in priod t is dnotd $d t Th timing is th following: Priod 1 Priod 2 Priod 3 Dividnd $d 2 Dividnd $d 3 Intrst rats i 1 and r 1 Inflation π 1 Intrst rats i 2 Inflation π 2 and r 2 Assum that th stock pric quals th xpctd prsnt discountd valu of dividnds. Answr th following qustions, which count 5 points ach: a) What is th rlationship btwn 1+i t, 1+r t, and 1+π t? Answr: (1+ i t ) = (1+ r t )(1+ π t ) Studnts using th approximation i t = r t + π t lost 1 point. b) Writ down th nominal xpctd prsnt valu (in priod 1) of a stock that pays an xpctd dividnd of $1 in ach priod 2 and 3; and dnot it $Q. (Hint: $Q is a function of $d 2, $d 3, i 1, i 2 ) Answr: Th nominal xpctd prsnt discountd valu is: $Q = $1 / (1 + i 1 ) + $1 / [(1 + i 1 ) (1 + i 2 )] c) Using your answrs from parts a) and b), what is th impact on th dollar valu $Q of an incras in xpctd inflation from priod 1 to 2, assuming that th ral intrst rat dos not chang and that th nominal valu of xpctd dividnds do not chang? Explain in words. Answr: Using a) and b) w gt: $Q = $1 + $1 / [(1+ r 1 )(1+ π 1 )] + $1 / [(1+ r 1 )(1+ π 1 ) (1+ r 2 )(1+ π 2 )] As it is assumd that th dividnd is fix in nominal trms, and th ral intrst rat is fix, this implis that an incras in xpctd inflation lowrs th nominal stock pric. Th xplanation is that inflation maks a givn nominal valu worth lss in th futur, 6

7 i.. prics ar xpctd to b highr in th futur, so that th dividnd of $1 buys lss. This maks stock prics fall today. Th xplanation was worth 2 points. d) Assum that th ral intrst rat is fixd, and that th dividnd in priod 2 and 3 ar fixd in ral trms. What is th impact on th ral valu of th discountd stram of dividnds of an incras in xpctd inflation from priod 1 to 2? Answr: Th ral valu dos not chang, as it is unaffctd by th incras in xpctd inflation. Th ral stock pric is: Q = d + d / (1+ r 1 ) + d / [(1+ r 1 ) (1+ r 2 )] whr d dnots th ral dividnd (dollar dividnd dividd by th pric dflator), and Q dnots th ral stock pric. ) Assum that thr is an unxpctd incras in mony supply in priod 1. What is th short run impact of this policy on i 1, r 1 and π 1? Answr: i 1, r 1 fall (2 points ach), π 1 is fixd in th short run (1 point). This can b sn in a standard IS-LM diagram. f) Finally, th cntral bank prsidnt wants to chang th stock pric. Using your answr from part ), and assuming that $d 2 is an incrasing function of output and xpctd inflation, what is th impact of th unxpctd incras in mony supply on th prsnt discountd valu of dividnds? Answr: Th stock pric incrass in th short run. In th short run, priod 1 nominal intrst rat falls, and output incrass, both lading to a highr stock pric. In th mdium run, inflation and also xpctd inflation incrass, again lading to a highr nominal stock pric. So th ffcts ar unambiguous. 7