Some persons are counted as out of the labor force because they have made no serious or recent effort to look for work

S ECTION 1: M ULTIPLE C HOICE Q UESTIONS1. Some persons are counted as out of the labor force because they have made no serious orrecent effort to look for work. However, some of these individuals may want to work eventhough they are too discouraged to make a serious effort to look for work. If these individualswere counted as unemployed instead of out of the labor force, then(a) both the unemployment rate and labor-force participation rate would be higher.(b) the unemployment rate would be higher and the labor-force participation rate would belower.(c) the unemployment rate would be lower and the labor-force participation rate would behigher.(d) both the unemployment rate and labor-force participation rate would be lower.2. Suppose a central bank implements a monetary expansion. Which of the following wouldwe expect to occur in the medium run?(a) an increase in output(b) an increase in the interest rate(c) an increase in the nominal wage(d) all of the above(e) none of the above3. A tax cut combined with tight money, as was the case in the United States in the early 1980s,should lead to a(a) rise in the interest rate and a fall in investment.(b) fall in the interest rate and a rise in investment.(c) rise in both the interest rate and investment.(d) fall in both the interest rate and investment.4. A decrease in the price level shifts thedemand curve.curve to down (or to the right), and the aggregate(a) IS; shifts tot he right(b) IS; does not shift(c) LM; shifts to the right(d) LM; does not shift5. If the investment demand function is I = c − di and the quantity of real money demanded iseY − f i, then monetary policy is relatively potent in influencing aggregate demand when disand f is.(a) large; small1(b) small; small(c) small; large(d) large; large6. A movement along an aggregate demand curve corresponds to a change in income in theIS-LM model, while a shift in an aggregate demand curve corresponds to a change inincome in the IS-LM model.(a) resulting from a change in monetary policy; resulting from a change in fiscal policy(b) resulting from a change in fiscal policy; resulting from a change in monetary policy(c) at a given price level; resulting form a change in the price level(d) resulting form a change in the price level; at a given price level7. For this question, assume that the economy is initially operating at the natural level of output.We know with certainty that a simultaneous reduction in taxes and reduction in the moneysupply will cause which of the following?(a) an increase in output and an increase in the aggregate price level in the short run(b) a reduction in output and a reduction in the nominal wage in the short run(c) a reduction in investment in the medium run(d) a reduction in the interest rate in the medium run(e) an increase in the aggregate price level, no change in output, and no change in theinterest rate in the medium run8. Crowding out occurs when an increase in government spendinginvestment.the interest rate and(a) increases; increases;(b) increases; decreases;(c) decreases; increases;(d) decreases; decreases;9. If the short-run IS-LM equilibrium occurs at a level of income below the natural level of, shifting thecurve down (oroutput, then in the medium-run the price level willto the right) and returning output to the natural level.(a) increase; IS(b) decrease; IS(c) increase; LM(d) decrease; LM210. Suppose people in the adult population in a small country are classified based on their age:Labor Force StatusNumber employedNumber unemployedNumber in Populationless then 5555 and older400,00025,000600,000100,0007,000200,000Suppose that the natural rate of unemployment is 5% for those under 55 and 3% for those 55and older. The cyclical unemployment rate for(a) those under 55 is 0.88%, which is greater than the cyclical unemployment rate for those55 and older.(b) those under 55 is 0.88%, which is less than the cyclical unemployment rate for those55 and older.(c) those under 55 is -0.83%, which is greater than the cyclical unemployment rate forthose 55 and older.(d) those under 55 is -0.83%, which is less than the cyclical unemployment rate for those55 and older.(e) 0 for both age groups.S ECTION 2: S HORT A NSWER Q UESTIONS1. A decrease in government spending reduces output more in the aggregate expenditure modelthan in the IS-LM model. Explain why this is true.2. Consider the following economy. The goods market is described byC = c0 + c1 (Y − T )T = t0 + t1 YI = b0 + b1 Y − b2 iG = g0 ,where the definitions of variables follow the text. The money market is described byMsM0=PPMd= µ0 + µ1 Y − µ2 i,Pwhere Ms is nominal money supply, M0 is the nominal money target set by the central bank,µ1 determines the relative increase in money demand due to an increase in income, and µ2determines the responsiveness of real money demand to a change in the nominal interest rate.(a) Solve for the IS curve (Y as a function of i).3(b) Solve for the LM curve (i as a function of Y ). How does monetary policy affect thegoods market in this model?(c) Solve for equilibrium output, Y , where the IS and LM curves intersect. Graph thecurves on a single figure. Label the axes and curves. Show the expressions for theintercepts and slopes of both curves. What happens to the slope of the LM curve whenreal money demand is more responsive to interest rates (i.e., as µ2 increases)? What isthe economic interpretation?(d) What is the government spending multiplier? What is the monetary policy multiplier?What is the difference between the two multipliers? Under what condition is the monetary policy multiplier larger than the government spending multiplier? What is theeconomic interpretation of this condition?(e) Graph the money market and IS-LM models (see Figure 5-4 in the text for an example)under the condition is the monetary policy multiplier larger than the government spending multiplier. Accurately depict the slopes of the money demand, LM, and IS curves.Show the ceteris paribus effect of an increase in Ms from M0 to M1 where M0 < M1 .Use an arrow to depict which way the LM curve shifts. Label the intercept of both LMcurves using the expression from part (c). What is the effect on equilibrium output?What is the drawback of the ceteris paribus assumption in this model? (Hint: Considerthe price level, P . Why can’t output rise forever by increasing the money supply?).3. Thus far we have assumed taxes are levied lump-sum. In reality, however, this is not thecase. Taxes are levied proportionally against income. Consider the following equations:C = c0 + c1 Y D ,YD = (1 − τ )Y,I = b0 ,G = g0where c0 , c1 , and τ (the income tax rate) are parameters, and G and I are both exogenous.(a) Solve for equilibrium output.(b) What is the multiplier? Does the economy respond more to changes in autonomousspending when τ = 0 or when τ > 0? Explain.(c) Explain the intuition behind how changes in autonomous spending affect equilibriumoutput and how a positive income tax rate changes the dynamic multiplier process.(d) Write a mathematical expression that shows the dynamic multiplier process.(e) Show that your expression in part (d) equals the multiplier from part(b).(f) Show the dynamic income multiplication process graphically in the goods market givenan increase in G from G0 to G1 . Be sure to label the intercept and slope of the aggregate demand curve as well as show any shifts in curves and changes in equilibrium.Describe how the goods market moves from the initial to the final equilibrium.(g) Suppose the government decreases the income tax rate (assume everything else isfixed). What does the model of the goods market predict will happen to aggregateincome? What if τ = 1?44. Show and fully explain the short run and medium run effects of the monetary authoritydeciding to decrease the nominal money stock. In order to receive full credit, you mustutilize both the IS-LM and AD-AS graphs. In explaining your answer you must take intoaccount price level effects and thoroughly explain all economic reactions. Be sure to statethe overall impact on output, prices, the nominal interest rate, and investment in both theshort- and medium-runs.ECON304: Intermediate Macroeconomics Problem Set #2 Solutions5