QUIZ 8: Macro – Winter 2008

Name: ______________________

Section Registered (circle one): 8:30 10:00 6:00

Quiz assumptions (READ!): Use the models developed in class and assume all curves are well behaved (i.e., IS slopes down in standard ways, LM slopes up in standard ways, etc.). Also, assume: 1) all consumers are non-liquidity constrained, non-Ricardian PIH (as developed in class), 2) NX = 0, 3) expected inflation has no effect on money demand, 4) all changes are permanent and unexpected unless told otherwise, 5) there is no income effect on labor supply (i.e., actual or expected PVLR changes do not change labor supply – however PVLR is STILL allowed to change and affect consumption – it just does not affect labor supply), 6) the economy is initially in long run equilibrium at Y*, 7) no monetary or fiscal policy takes place unless I tell you otherwise, and 8) TFP, taxes, consumer confidence, value of leisure, population, government spending, and the nominal money supply do not change unless I tell you they change

NOTE: Unless I tell you otherwise, when I ask you about the LONG RUN, you should compare the initial condition in the economy with the eventual long run position of the economy (compare position 0 directly with position 2 – using our notation from class).

Question 1 (circle all the true answers – 20 points total, 2 point each)

Given the above assumptions, which of the following are definitely true about a permanent increase in the price of oil? Assume that prices in the short run increase!

We went over this question in class. Let me summarize:

In short run: Both AD and SRAS shift in (Y will fall and P will increase (given the quiz assumption). Note: In reality, P could have done anything – but, I told you to assume that P increased in the short run).

IS will shift in (as C falls and autonomous part of I falls – C falls because W/P will fall permanently (in the long run) and I falls because MPK falls – this is the same reason that the AD curve shifted in).

The LM curve will shift in (as P increases and M/P falls).

The net effect of the IS shifting in and the LM shifting in makes Y fall (we knew this from above) and makes r ambiguous.

The net effect on total investment is also ambiguous (as MPK falls (holding r constant) – I falls, but I is also a function of r and we do not know what happens to r).

In the labor market, the labor demand curve will shift in (as oil quantity falls (as oil prices increase). Labor demand falls because of the complementarity we assumed between oil quantity and workers.

In the long run, real wages will fall. N* will also fall in the long run (as will Y* as both N* and oil quantity fall).

In the short run in the labor market, W/P will also fall (as W is fixed and P increased). Where is the short run real wage relative to the long run new real wage? We do not know. N in the short run could be below or above the new N*. So, by definition, Y in the short run could be either above or below the new N*.

a. Output in the short run falls.

True

b. Output in the long run falls.

True

c. The labor demand curve will shift left in the short run.

True

d. Consumption will fall in the short run.

True

e. The marginal product of labor will fall in the long run.

True (MPN = W/P if we are on the firm’s labor demand curve)

f. The LM curve will shift left in the short run.

True

g. The labor supply curve will shift right in the short run.

False – there is no movement in the labor supply curve (we assumed there were no income effects on labor supply)

h. The IS will be shifted left in the long run.

True (IS shifts left and stays left – so does the AD curve).

i. Output in the short run will be lower than output in the long run.

False

j. Output per worker will rise in the short run.

False (Y/N = real wages – real wages fall in the short run).