Econ 304 Second Exam Fall 2009
Answer all questions in your blue book. Strive for legibility, and show all work so
that I can award partial credit if earned.
Part 1. What Has Just Been Defined? (5 points each) Indicate the term which
matches the definition given.
1. An equation that shows the relationship between inflation, expected inflation,
and the unemployment rate. PHILLIPS CURVE
2. The notion that errors in expectations are random. RATIONAL
EXPECTATIONS
3. An equation that shows the relationship between changes in the
unemployment rate and the growth rate of output. OKUN’S LAW
4. The result that changes in the money supply have no effect on real variables in
the long run. THE NEUTRALITY OF MONEY
Part 2 Work the Models (50 points) Answer the following two questions that
require the use of models we have discussed in class.
5. (30 points) Consider three models: (1) the IS-LM model, (2) the IS-LM AD-
AS model in the short run, and (3) the IS-LM model in the medium run. For
each of the disturbance rank the change in the target variable from largest to
smallest. Measure a change by giving the difference in absolute value
between the initial equilibrium (at a full medium run equilibrium) and the new
value predicted by the particular model. Your response should be Largest –
Model A, Second Largest – Model B, and Smallest – Model C. Show the
models you used to make these predictions.
a. Disturbance: Increase in Taxes Target Variable: Y
THE LARGEST CHANGE WOULD COME FROM THE IS-LM MODEL. THIS
CHANGE WOULD BE A MOVE TO THE LEFT OF AN IS CURVE ALONG A
GIVEN LM CURVE. THE SECOND LARGEST CHANGE WOULD COME
FROM THE IS-LM AS-AD MODEL IN THE SHORT RUN. THE IS CURVE
WOULD SHIFT TO THE LEFT CAUSING A MOVEMENT TO THE LEFT OF
THE AD CURVE. THE SHORT-RUN EQUILIBRIUM WOULD BE AT THE
INTERSECTION OF THE NEW AD AND THE AS CURVE. THE CHANGE IN Y
WOULD BE LESS THAN THE CHANGE FROM JUST THE IS LM MODEL
BECAUSE PRICES WOULD BE REDUCED AND SO THE RELEVANT LM
CURVE WOULD MOVE TO THE RIGHT AND DECREASE THE CHANGE IN
Y. THE SMALLEST CHANGE IN Y WOULD COME FROM THE MEDIUM
