Atul A. Dar Economics 3301.1 Assignment 3 November 2, 2017 This assignment is due in class on November 9th. You must use the same group you used for the last assignment. Those who made individual submissions can continue to do so. You will be marked for both the content the clarity of your answers. You must provide adequate explanations. Please see me if you have any questions. IMPORTANT: do not hand in assignments that are identical to those of others. Question 1 (10 points) With the help of the IS-LM open economy model with perfect mobility, examine the short-run impact of each of the following on equilibrium output, interest rates, and investment, and net exports under flexible exchange rates. You must draw graphs to support your answers. a. A worsening of business expectations b. A monetary expansion accompanied by a fiscal expansion Question 2 (8 points) Suppose the government uses fiscal policy to cut its deficit. Examine the impact on output, the interest rate, investment and net exports under fixed exchange rates. Support your answer with a graph. Question 3 (12 points) The following parts are based on the wage and price setting model discussed in class. Wage setting: W = Pe F(u, z̄), and price setting: W= P/(1+m). A. Explain how the natural rate of unemployment is determined. Draw a graph to support your answer. (4 points) B. In the short run, unemployment fluctuates around the natural rate due to errors in forecasting price levels, other things being equal. Explain clearly why, using your graph above to support your answer. (3 points) C. Consider a simple wage setting equation of the form: F(u, z̄) = a – bu, where a and b are positive constants. The price setting equation is the same as that given above. Suppose that the labour force is fixed at 1 unit, and P=Pe. 1. Based on this information, express the wage setting equation as a function of employment (N). (2 points) 2. Solve for the equilibrium natural level of employment (NN) or output (YN) since the two are the same in this version of the model. Use the expression for equilibrium output to determine how the natural rate of output will change in response to a decline in the market power of firms in setting price. You do not need to use algebra to answer this. However, you should show your reasoning based on your equilibrium expression. (3 points)
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