14.02 Principles of MacroeconomicsSpring 05Quiz 2Thursday April 14, 20057:30 pm - 9 pmPlease answer the following questions. Write your answers di-rectly on the quiz. There are 6 True/False questions, followed by3 long questions. The quiz is for a total of 100 points. There isa blank page at the end of the quiz to be used for scratch paper.Good luck!NAME:MIT ID NUMBER:TA:CLASS TIME:EMAIL:(Table is for corrector use only.)1 2 3 4 5 6 TotalI. T/FII. LQ 1II. LQ 2III. LQ 3Total1I. True/ False (30 points)Answer each as TRUE or FALSE (note - there is no uncertainoption), providing a few sentences of explanation for your choice.Each question counts for 5 points.1. If the growth rate of productivity is zero, then in order to maintainunemployment at the natural rate, the growth rate of output must equal thegrowth rate of the labor force.2. If the growth rate of output and the in‡ation rate are both zero in themedium run, a one-time monetary expansion (i.e., an increase in the level of thenominal money stock) de creases the nominal interest rate in the medium run.23. The nominal interest rate has always been higher than the real interestin the US since 1978.4. The higher the level of wage indexation, the steeper the Phillips curve.35. The more forward looking consumers and …rms are, the ‡atter the IScurve.6. According to the basic AS-AD model, an increase in the …scal de…cit willhave no impact on investment in the medium run, if the central bank keepsnominal money supply constant.4II. AS-AD in levels (30 points)Consider an economy of the following descriptionConsumption demand is given by : C = 4 + 0:3Y (no taxes)Investment demand is given by : I = 0:2Y iGovernment spe ndin g is : G = 0Money demand is given by : M=P = Y iMoney supply is constant : M=P = 2Wage setting is described by : W=Pe= 1 uThe production function is Y = N , and the markup is 25%The labor force is 10, and in the above description i is stated in %(i) Assume that Pe= P: Write down equations for the equilibrium in eachof the three markets. (5 points)5(ii) Write down the equation for the AS curve. (5 points)(iii) Write down the equation for the AD curve if the stock of nominal moneyis 1 unit. (5 points)6(iv) Solve f or the short-run equilibrium values for Y , P , and i if Pe= 1. (5points)(v) Solve for the medium-run equilibrium value s for Y , P , and i: (5 p oints)7(vi) Explain in words how the economy goes from the s hort-run equilibriumto the medium-run equilibrium. Can a monetary expansion help the adjust-ment? If s o, how? (5 points)8III. Long question - Stock prices rise? (15 points)Excerpted from a popular …nancial news website from Friday, April 1, 2005: "Stocks rose in the …rst half hour of trading after the release of a weaker-than-forecast March jobs report. While that would seem negative, stock investorsworried about possible more aggressive rate hikes from the Federal Reservetook comfort in the numbers, which pointed to moderate economic growth andlittle upward pressure on wages."Question : A weaker-than-forecast jobs report implies that employment (andtherefore output) is lower than expected. This would ordinarily be bad news("While that would seem negative...."), yet stocks rose. Explain (note that theanswer is in the quote itself, but you must explain what is going on instead ofmerely reproducing the quote).9IV. Long question - Investment Decision (25 points)Imagine that you are a medical doctor and want to open your own clinic inyear t + 1. In order to do so, you need to rent a piece of med ical equipment.The nominal annual rental payment is $Zt. You expect it to increase at rateg (not in percentage) per year. For example, $Zt+2= $Zt+1(1 + g) :The nominal interest rate this period (from t to t + 1) is it(again, notin percentage), You have no idea whether the nominal interest rate will behigher or not in year t + 1. To play safe you form expectations such thatiet+1= iet+2= ::: = iet+N= it:Suppose that you decide to rent the equipment for m years. The rentalcontract stipulates that, if for any reason, the equipment does n ot work, anotherwill be rented to you.(i) Derive the expected present value of rentals on the equipment for thenext m years. (10 p oints)10(ii) Suppose that you are instead o¤ered the opportunity to buy the equip-ment today, at price Pt. You expe ct not to be able to resell it, so Pet+m= 0:Should you buy or rent? Derive the condition under which you buy, andexplain it in words. (10 points)(iii) Suppose the interest rate (current, and expected) increases. How do e sthis a¤ect your decision? (5 points)11Scratch
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