Third Midterm Examination
November 21, 1997

First Part (15 point questions)

For each of the following statement, state whether you agree or disagree with the statement and explain why. It is not sufficient simply to write "True" or "False". Your reason is as important, if not more so.

1. The Long Run Aggregate Supply Curve is upward sloping.

The long run supply curve is vertical, not upward sloping. Changes in the price level will not lead to an increase in output. Thus the answer is false.

2. By engaging in open market operations to increase or decrease the Federal Reserve System's holding of government bonds, the System can increase or decrease the money supply dollar for dollar with its purchases or sales of bonds.

By engaging in open market operations, the Federal Reserve System will increase bank reserves, but thanks to the bank's ability to create money, the increase in the money supply will be more than one-to-one. Thus the answer is false

3. If the short run aggregate supply curve is upward sloping, then a rise in velocity will reduce GDP, both now and in the long run.

Recall that MV = PY, so that Y = MV/P. Thus, assuming a short run aggregate supply curve that is upwards sloping, a rise in velocity will increase short run GDP, but have no impact on GDP in the long run. Thus the answer is false

4. The imperfect information theory of the aggregate supply curve predicts either a short run upward sloping aggregate supply curve or a long run Phillips curve. (Note: the wording is carefully chosen so that you have to respond to two issues.)

It does predict a short run upward sloping aggregate supply curve, but not a long run Phillips curve. Thus the answer is true and false.

Second Part (20 point questions)

1. An International Research Team has collected the following data on the price level and GDP for East, West, and Central Chase for the period 1990-1996. Prior to that time, all three economies had a stable no-growth GDP of $100,000 and stable prices, with the price level equal to 100. As you can see, the economies have not been so stable since then.

Economists have debated whether these shocks were due to shifts in the aggregate supply or aggregate demand curve. HINT: if the long run aggregate supply curve shifted, it only shifted once.

	GDP and Price Data for East Chase		GDP and Price Data for West Chase		GDP and Price Data for Central Chase
Year	GDP (1989 $)	Price Level (1989= 100)	GDP (1989 $)	Price Level (1989= 100)	GDP (1989 $)	Price Level (1989= 100)
1990	100,000	100	100,000	100	100,000	100
1991	91,000	95	96,000	95	105,000	105
1992	93,000	93	93,000	93	104,000	107
1993	94,000	91	93,000	91	103,000	108
1994	97,000	90	93,000	91	102,000	109
1995	100,000	89	93,000	91	100,000	110
1996	100,000	89	93,000	91	100,000	110

A. In East Chase

	Yes	No	Maybe
Did the aggregate demand curve shift?	Yes
Did the long run aggregate supply curve shift?		No

Explain your answers - briefly. A long dissertation is not required to answer these questions.

The aggregate demand curve did decrease, and at one point, GDP was 9,000 below long run aggregate supply. Note that the fact that GDP bounced back is proof of an aggregate demand shock.

B. In West Chase

	Yes	No	Maybe
Did the aggregate demand curve shift?			Maybe
Did the long run aggregate supply curve shift?	Yes

Explain your answers - briefly. A long dissertation is not required to answer these questions.

GDP never came back, so we know that there was a decrease in aggregate supply. Did aggregate demand shift as well? We will never know.

C In Central Chase

	Yes	No	Maybe
Did the aggregate demand curve shift?	Yes
Did the long run aggregate supply curve shift?		No

Explain your answers - briefly. A long dissertation is not required to answer these questions.

Here, the aggregate demand curve did shift to the right, but since GDP came back to 100,000 we know that there was no shift in aggregate demand.

2. In our discussion of real business cycles, we saw how a shift in aggregate supply could affect several variables, Specifically; we showed how a shift in aggregate supply could impact

1. Real GDP

2. The Number of People Working

3. The Average Wage Rate

4. Capital Utilization

5. Corporate Profits

6. Investment as a percentage of GDP

7. Real Interest Rates

8. Consumption as a Percent of GDP

9. The Price Level (As you recall, this effect was ambiguous)

Suppose now that, for whatever reason, there is a decline in total factor productivity. Show what the impact will be on each of these variables. Specifically, fill in the following table, and then explain your answers. Note: It is not enough to fill in the table. You must give a complete explanation of each of the impacts.

See the notes for this one. The lecture notes do it as an increase in total factor productivity, but here you are asked for a decrease in total factor productivity.