Quiz 7: Macro Fall 2007
Name
_____________________
Section
Friday
Saturday
For this quiz, make the following assumptions. Use the model of the economy developed
in class.
Assume consumers are non-liquidity constrained, non-Ricardian PIH
consumers. Assume there are no income effects on labor supply. Assume NX is fixed
at zero. Assume expected inflation is always constant. Assume no monetary or fiscal
policy takes place, unless otherwise indicated. Assume all changes are unexpected and
permanent (unless told otherwise). Assume changes in government spending have no
effect on TFP. Lastly, assume the economy is initially in long run equilibrium (Y0 = Y*).
Note: When discussing the long run, compare the initial conditions to the new long
run equilibrium.
Question 1
True/False/Uncertain: Explanation determines the grade (like on the midterm). Focus on
the portion of the statement below that is italics. Justify your answer with intuition.
Again, your answer should be no more than 3 sentences. (4 points)
Suppose further that there was a permanent (one time) increase in government spending.
Suppose the only Federal Reserve policy goal is to manage the inflation rate (i.e., keep P
close to P0).
In the long run, according to the models developed in class, a permanent increase in
government spending will lead to a greater crowding out of investment if there is no Fed
intervention compared to the situation where the Fed intervenes. Assume that the Fed
intervention, if it exists, takes place between the short run and the long run. (Note:
“crowding out” was defined extensively in class last week). (Hint: If you say true, make
sure you say why. If you say false, make sure you say why).
Quiz continued on back
As always, for questions 2-4, circle the true answers. The question stems may have
more than one true answer (or no true answers).
Question 2
Suppose that the central bank conducts a one-time permanent increase in the nominal
money supply (from M0 to M1). Which of the following are definitely true? (4 points)
a.
b.
c.
d.
In the short run, the percentage increase in the nominal money supply will be
greater than the percentage increase in the price level.
In the long run, the percentage increase in the nominal wage will be greater than
the percentage increase in the nominal money supply.
In the short run, the percentage increase in the price level will be greater than the
percentage increase in the nominal wage.
In the long run, the percentage increase in the price level will be greater than the
percentage increase in the nominal money supply.
Question 3
Suppose there is a permanent increase in government spending (with no Fed
intervention). Which of the following are definitely true? (6 points)
a.
b.
c.
d.
e.
f.
Between the short run and the long run, both consumption and investment will
fall.
The labor supply curve will shift right in the short run.
The LM curve will shift right in the short run.
The SRAS will be shifted left in the long run.
The real money supply will be unchanged in the long run.
Nominal wages will increase in the short run.
Question 4
Suppose there is a permanent decline in consumer confidence. Assume that this decline
in consumer confidence was only a change in expectations. In other words, the change is
not associated with any actual change in TFP (i.e., TFP is held constant). Instead of
having the economy correct itself, suppose the Fed intervenes in the short run to return
the economy to its original level of output. If the Fed intervenes, which of the following
are true? (Assume that the Fed intervention takes place after the short run). (6 points)
a.
b.
c.
d.
e.
f.
Total investment will be unchanged in the long run.
The real money supply will fall in the long run.
Government deficits will increase in the long run.
The labor demand curve will shift left in the short run.
The IS curve will shift right between the short run and the long run.
Prices will increase in the long run.