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# Econ 204 Assignment 3 – Suppose that the Philips curve

Subject: Economics / Microeconomics
Question
Econ 204 10 points . Assignment 3 (Due: December 14th in Class)
I. Philips Curve 5 points Suppose that the Philips curve is given by
?t = ?et + 0.1 -2ut
a. What is the natural rate of unemployment?
b. Assume ?et = ??t-1
and suppose that ? is equal to 0. Suppose that the rate of unemployment is initially equal to the
natural rate. In Year t, the authorities decide to bring the unemployment rate down to 3% and
hold it there forever. Determine the rate of inflation in years t, t+1, t+2, and t+5.
c. Do you believe the answer given in (b)? Why or why not? (Hint: Think about how people are
likely to form expectations of inflation.)
Now suppose that in year t+5, ? increases from 0 to 1. Suppose that the government is still
determined to keep u at 3% forever.
d. Why might ? increase in this way? What will the inflation rate be in years t+5, t+6, and t+7.
e. Do you believe the answer given in (d)? Why or why not? II. Open Economy 5 points Consider an economy where
C=200+0.25(Y-T)
I=150+0.25Y-1000i
G=250, T=200
(M/P)d=2Y-8000i
(M/P)s =1600
X = 0.3Y*, IM =0.2Y,
? (real exchange rate) = 2, Y* is foreign output (Y*=900) 1 a. Calculate the multiplier if the economy is closed and the multiplier if the economy opens up.
Explain the economic intuition why two are different with 3-5 sentences.
b. Solve for the equilibrium level of income (Y) for the open economy (Yopen) and calculate the