Economics 358 Assignment 2 (version B)
This assignment has a maximum total of 100 marks and is worth 20 percent of your total
grade for this course. You should complete it after completing your course work for Units
6 through 9. Answer each question clearly and concisely.
1. Define the natural rate of unemployment in terms of wage-setting and price-setting
relations. Write the equation that expresses the natural rate of unemployment in
terms of these relations. Using an appropriate diagram, explain the effect of a
decrease in the markup on the natural rate of unemployment.
(20 marks)
2. a) What is the shape of the aggregate supply (AS) curve if
(i) nominal wages and prices are flexible and competitively determined?
(5 marks)
(ii) nominal wages are downwardly rigid? (5 marks) b) Is the AS curve apt to be more or less elastic with respect to the price level in the
medium-run/long-run as opposed to the short-run?
(10 marks)
3. Answer the following questions assuming known IS and LM curves.
a) Derive the associated aggregate demand (AD) curve.
b) Why does it have a negative slope? (5 marks)
(5 marks) c) What is the effect of an increase in government spending on the AD curve?
(5 marks)
d) What is the effect of an increase in real money balances on the AD curve?
(5 marks)
4. Assume the economy starts at the natural level of output. Using AS–AD analysis,
compare the adjustment in the economy to an increase in immigrant labor due to war
in Syria under flexible exchange rates with
a) downwardly rigid wages and prices.
b) competitively determined wages and prices.
5. Consider the Phillips curve (10 marks)
(10 marks) πt = πt-1 – 0.5(ut – 0.03). a) What is the natural rate of unemployment? Graph the short-run and long-run
relationships between inflation and unemployment.
(5 marks)
b) How much unemployment is necessary to reduce inflation by 5%? Compute the
sacrifice ratio. Show your work.
(5 marks)
c) Do flexible exchange rates permit a country to pick its own unemploymentinflation trade-off target?
(10 marks) ECON 358v1 Assignment 2 (version B) November 2016

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