Preparing for the final exam

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Warning

This is not an exhaustive list of questions or even topics. You still need to review all material and it would be a good idea to create your own questions to try to answer.

Warning

The final exam is comprehensive, so it is highly reccomended to use the material from our previous study guides to study.

Inflation

1. Explain how inflation expectations can be “self-fulfilling”.

2. For each of the following, determine whether inflation expectations, demand-pull inflation, or cost-push inflation — and hence inflation overall — will change.

   1. A rapid influx of foreign investment causes the output gap to become more positive.

   2. The president unexpectedly announces a tariff on aluminum and steel.

3. Identify whether the following will represent a shift in the Phillips curve or a movement along the Phillips curve. Illustrate with a graph.

   1. Consumer confidence increases unexpectedly and causes the output gap to become more positive.

   2. Inflation last year was far greater than even the best forecaster expected even though the output gap was zero.

   3. A devastating late spring freeze destroys crops across the eastern United States, which causes the output gap to become more negative.

IS-MP-PC Model

1. The economy is experiencing an output gap of −3%. Discuss how monetary policy or fiscal policy could be used to raise actual output toward potential output. Could monetary policy and fiscal policy be used together? If so, how? Illustrate in the IS-MP-PC model.

2. Consider the following economy:

   IS Function:

   $$Y=3\times (600-800\times r)$$

   MP Function:

   $$r=0.03-0.02+0.04$$

   PC Function:

   $${\pi }_t-0.02=\frac{(Y-Y^P)}{Y^P}+0$$

   1. What are inflation expectations in this model?

   2. Solve for equilibrium

   Assume your answer to the previous question is potential output. Now assume a sudden collapse in global trade (perhaps due to geopolitical conflict) has caused exports to fall by $50.

   3. Where do exports show up in the equations above?

   4. Calculate new equilibrium GDP, the output gap, unexpected inflation and total inflation.

   5. Illustrate this in an IS-MP-PC model.

   6. Notice that if the Federal Reserve increases interest rates the effect on GDP is 3*-800. By how much does the Fed have to lower interest rates to combat the effect of the collapse in trade?

   7. What categories of spending are most likely affected by this policy from the Federal Reserve?