ANALYTICAL PROBLEMS

1. Suppose that the government provides more job training programs and job search services so as to help workers improve productivity and find jobs.

a. What will be the effect on the natural unemploy­ment rate? How does this affect the expectations- augmented Phillips curve and the long-run Phillips curve?

b.

2. Two extended classical economies (in which the misperceptions theory holds) differ only in one respect: In economy A money growth and inflation have been low and stable for many years, but in economy B money growth and inflation have fluctu­ated erratically between very low and very high lev­els. When producers in economy B observe changes in the prices of the goods they produce, from past experience they usually attribute these changes to fluctuations in the overall price level rather than to changes in the relative prices of their goods.

Will the slope of the short-run aggregate supply curve for economy B be higher or lower than the slope of the curve for economy A? What about the slope of the Phillips curve?

3. In this problem you are asked to show that the expectations-augmented Phillips curve (derived in the text using the extended classical model) can be derived using the Keynesian model.

Consider a Keynesian economy in which full­employment output is constant, and in which the nominal money supply has been growing at 10% per year for some time and is expected to keep growing at that rate in the future. To avoid some technical compli­cations, suppose that, instead of growing continuously over time, the money supply is increased by 10% each December 31 and then held constant until the next December 31. Monopolistically competitive firms reset their prices on December 31 of each year at the level that they expect will allow them to sell the full-employment level of output during the coming year.

a. Show how the AD curve, SRAS curve, output, the price level, and the expected price level evolve over time in this economy. What are the values of unan­ticipated inflation and cyclical unemployment?

b. Now suppose that on June 30, 2023, the money supply is unexpectedly raised by an additional 5%. However, the central bank announces—and firms believe—that this extra increase in the money supply is a one-time-only increase and that next December 31 the central bank will return to its policy of increasing the money supply by 10%. (Thus the total increase in the money supply between January 1, 2023, and December 31, 2023, is approximately 15%.) Firms don't change prices until December 31, as usual, but when they do they respond fully to the new information about money supply growth.

What are the actual and unanticipated inflation rates during 2023? Is cyclical unemployment posi­tive, negative, or zero (on average) during 2023? Relate your results to the expectations-augmented Phillips curve.

4. Some economists have suggested that someday we will live in a “cashless society" in which all busi­nesses (including stores) and banks will be linked to a centralized accounting system. In this system you will be able to pay for purchases directly from your bank account or phone without using cash. What are the costs of anticipated inflation in a cashless society? What are the costs of unanticipated inflation?

5. To fight an ongoing 10% inflation, the government makes raising wages or prices illegal. However, the government continues to increase the money supply (and hence aggregate demand) by 10% per year. The economy starts at full-employment output, which remains constant.

a. Using the Keynesian AD-AS framework, show the effects of the government's policies on the economy. Assume that firms meet the demand at the fixed price level.

b. After several years in which the controls have kept prices from rising, the government declares vic­tory over inflation and removes the controls. What happens?

6. How would each of the following likely affect the natural unemployment rate?

a. A new law prohibits people from seeking employ­ment before age eighteen.

b. A new Internet service, Findwork.com, makes it easy for people to check on the availability of jobs around the country.

c. The length of time that workers who are unem­ployed can receive government benefits increases from six months to one year.

d. A shift in the public's buying habits greatly expands the demand for sophisticated consumer electronics while reducing the demand for tradi­tional consumer goods and services, such as cloth­ing and restaurant meals.

e. Tight monetary policy, introduced to get the inflation rate down, drives the economy into a recession.

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