04 Jun Econ 2470 (A01) Macroeconomic Theory and Its Applications 1
uestion
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Econ 2470 (A01)
Macroeconomic Theory and Its Applications 1
Winter 2015
Practice Questions Set 2
Question 1
Suppose the Bank of Canada changes the level of money supply in the economy. Using appropriate
model(s), illustrate the effects of this policy change on the real wage, employment, output, real interest
rate, investment, and the price level in the short run, and in the long run.
1. What assumptions and/or considerations will you have to make to fully evaluate the effects of
this policy change? State those clearly.
2. Suppose you change your assumptions above, what will be the implications for the real wage,
employment, output, real interest rate, investment, and the price level in the short run, and in the
long run.
3. Will you support the Bank’s decision? Why or why not?
Question 2
What are the implications of the rational expectation hypothesis for the monetary policy effects on
output?
Hint: The rational expectation hypothesis implies that anticipated policies will have no effect on the
real economic activities, because people understanding the effects of the announced policies will react
accordingly.
Question 3
Why is monetary policy useful even though money is neutral?
Hint: Use a model to illustrate your answer
Question 4
Suppose the government of Alberta, in response to fluctuating crude oil prices temporarily changes it’s
spending by 20% over the previous year’s level. Use appropriate model(s) to show the effects of this
policy change on the real wage, employment, output, real interest rate, investment, and the price level
in the short run, and in the long run. State clearly any assumptions you made in your analysis.
Question 5
Analyze the short-run and long-run effects of an unanticipated decrease in the money supply in the
misperceptions model. What happens to output, the price level, and the expected price level in both the
short run and long run?
Hint: (Use graphs to illustrate this)
The reduction in money supply shifts the AD curve left, reducing output and the price level, while the
expected price level is unchanged, since the decrease in money supply was unanticipated. In the long
run, the SRAS curve shifts down as people reduce their expected price level. The economy returns to
full-employment output, but at a lower price level.
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