ASSIGNMENT

A hard copy of the assignment should be handed in at the beginning of class. Homework should be typed, while graphs can be drawn by hand. Handwritten work will be accepted if it is extremely neat and legible.

Note: Briefly means 1-2 sentences. Working together is good, but write your own version (in your own words!).

1. We want to study what happens to GDP and prices as an economy is hit by a shock. For each question, mark clearly the axis, the curves, and the equilibria.

(i) Draw the aggregate demand curve and the short and long run supply curves for a country in one diagram. Assume that the country starts out in long-run equilibrium.

(ii) The economy is hit by a negative demand shock. Illustrate the shift(s) in your diagram. Mark clearly the price level and output in the new equilibrium as P2, Y2.

(iii) What could have caused the negative demand shock? List at least 2 events.

(iv) After the negative demand shock, while the economy is in Y2, what is the unemployment rate like compared to full employment?

(v) What will happen over time in this economy if it is left to itself, with no intervention from economic policy? Illustrate how curve(s) will shift, and explain briefly why. (Max 2 sentences). Mark clearly the new long-run equilibrium levels of output as Y3 and the price level P3.

(vi) Assume instead that the government decides to use fiscal policy to revert the economy to long-run equilibrium because they are concerned about the situation. The government decides to increase spending by $220 mill. The government estimated that MPC = 0.55. Which curve will shift, and by how much? Illustrate the shift in your graph.

2. Go to bea.gov. On the right hand side, you will find various new data.

(i) What was the real GDP growth in the 3rd quarter (Q3)?

(ii) Follow the link to the press release: What was the real GDP growth rate in the 2nd quarter?

(iii) You can see in the graph with real GDP growth rates that real GDP growth rate varies a lot by quarter, but what are some reasons that real GDP has on average a clear positive growth rate over time? (i.e. what are some of the factors that explain trend growth in real GDP over time?)

(iv) What was the exact timing of the press release? (On top of the release)