Review Questions for Midterm #2
Intermediate Macroeconomics
ECO 241 / Waters
The second midterm covers the material for Chapters 6-9 with some related
material from earlier chapters as well as parts of Chapters 10 and 22. There
will be both multiple choice and essay / problem questions. The latter will
be inspired by the review questions below.
1) Using a graph for wage and price setting, show the effect of the decrease in
unionization in the U.S. on the natural rate of unemployment in the medium run. What
would be the effect on the natural rate of output?
2) Show the effect of an increase in the money supply in the short and medium run using
an AS-AD graph. Does your graph show money neutrality? Explain briefly.
3) Recently prices on commodities used in manufacturing such as copper and platinum
have risen substantially. If this is a permanent increase, show the effect on an AS-AD
graph.
4) Starting from the natural rate on an AS-AD graph, show an increase in government
spending that would improve productivity. Give an example of such spending. If the
spending did not improve productivity, what would happen to the equilibrium price
level?
5) On graphs for IS-LM and AS-AD, show the short and medium run effects of a fall in
autonomous investment.
6) If unemployment starts at the natural rate and the Federal Reserve increases the
money supply, the short and medium run effect on a graph of the Phillip’s Curve.
7) If price and inflation expectations are above their true values, what does this mean for
the levels of unemployment and inflation compared to their natural rates. Show this
situation on AS-AD and Phillip’s curve graphs.
8) Using the wage and price setting equations, explain why aggregate supply slopes up in
the short run.
9) Show a recessionary gap on an AS-AD graph and a Phillips Curve graph. If the Fed
acts to close the gap, what would they do? Show the changes on the graph.
10) Show a liquidity trap on an IS-LM graph. Explain (and show) why monetary policy
alone cannot increase output.
Answers: 13) MR:  = 3%; new gm = 5%; SR:  = 2.66, u = 5.33, gy = 2.33; sacrifice
ratio = 1
11) Write the equation for the Phillips Curve. Show that unemployment is independent
of inflation under rational expectations.
12) Starting from the natural rate, show the effect of a tax cut on an AS-AD graph
assuming the productivity increases with the cut.
13) Use the following macro model to answer the questions below.
gy,t = gm,t - t

tetut
ut – ut-1 = 0.5(3% - gy,t)
Find the medium run values of gy,t and ut. If gm,t = 6%, what is the medium run
value of t ? If the Fed wants inflation to be 2% in the medium run, to what level should
they set gm,t ?
Starting from the initial medium run values, if the Fed makes this change in gm,t ,
find the one period (short run) change in unemployment, inflation and the growth rate of
output. Also find the (one period) sacrifice ratio.
Answers: 13) MR:  = 3%; new gm = 5%; SR:  = 2.66, u = 5.33, gy = 2.33; sacrifice
ratio = 1