PART 1
You should answer ALL questions from this section.
Question 1
The Phillips curve is named after economist A.W. Phillips, who examined U.K.
unemployment and wages from 1861-1957. Phillips found an inverse
relationship between the level of unemployment and the rate of change in
wages (i.e., wage inflation).
a) Write down a formula for the Phillips curve as discussed in the lectures
or textbook and describe your notation.
[4 marks]
b) Inflationary expectations are an important driver of the Phillips curve
relationship. What are three different ways inflationary expectations
might be modelled? Depict each graphically. [8 marks]
c) How might the response of a central bank to an external inflation shock
depend upon the way that the home population forms its inflationary
expectations?
[8 marks]
Question 2
Let’s assume our country is “Futureland” with only two sectors: Agriculture
and Mining. As we learned, labour market consists of demand side and the
supply side like any other markets. Let us have the demand for labour in
agriculture and mining as described by these equations:
= 100 − 4
= 200 − 6
We know L denotes the labour and W denotes wage in dollar for each sector
(Agriculture and Mining). Let us have Futureland with only 100 workers who
are able and willing to work in each of these two sectors. Workers are free to
move between these two sectors freely.
a) We assume that wages adjust to equilibrate labour supply and labour
demand. Calculate the wage and employment in each sector.
[8 marks]
b) Suppose a union establishes itself in agricultural sector and pushes
the wage in mining to $25. Calculate employment in agricultural sector.
[4 marks]
c) In the aftermath of the unionization of agriculture, all workers who
cannot get the highly paid union jobs move to the mining sector.
Calculate the wage and employment in mining sector.
[4 marks]
d) Now suppose that workers have a reservation wage of $15—that is,
rather than take a job at a wage below $15, they would rather wait for
a $25 union job to open up. Calculate the wage and employment in each
sector. What is the economy’s unemployment rate?
[4 marks]
Question 3
Federal Reserve Bank of New York hires you to give them policy advice when
shocks hit the economy. You are now an experience consultant and are going
to use the IS–LM analysis as a tool to predict the short-run effects of each of
the following shocks on the interest rate, output, consumption, and
investment. In each case, explain what Federal Reserve should do to keep the
output at its initial level. Be sure to use a graph your answers.
a) A wave of credit card fraud increases the frequency with which people
make transactions in cash.
[6 marks]
b) A best seller titled “Stop worrying about your pension” convinces the
general public to increase the percentage of their income devoted to
saving.
[8 marks]
c) Fed chooses a new “dovish” chair of monetary policy which as
consequence will increases expected inflation of the general public.
[6 marks]
PART 2
(You should answer ONLY ONE question from this section.)
Question 4
We live in a world with lots of uncertainty and our economic decisions would
be affected by the political turmoil, economic fluctuations and societal
changes. Let us assume that our expectations for the inflation are subject to
some random shocks and let’s model it as Et−1t = t−1 + t−1. Here t−1 is
random shock (i.e., increase in the price of fuel). This shock is normally
equally zero, but we know it deviates from zero when some events beyond
past inflation (contrast to adaptive expectation) causes expected inflation to
change.
a) Firstly, derive both the dynamic aggregate demand (DAD) equation and
the dynamic aggregate supply (DAS) equation in this slightly more
general model.
[5 marks]
b) Suppose the economy experiences an inflation scare. That is, in
period t, for some reason people come to believe that inflation in
period t+1 is going to be higher, so t is greater than zero (for this
period only). What happens to the DAD and DAS curves in period t?
What happens to output, inflation, and nominal and real interest rates
in that period? Explain.
[5 marks]
c) What happens to the DAD and DAS curves in period t+1? What happens
to output, inflation, and nominal and real interest rates in that period?
Explain. [5 marks]
d) In what sense are inflation scares self-fulfilling? [5 Marks]
Question 5
Recall the engaging outdoor exploration of economic concepts during the
London Economics Walk. Now, let's dive into a question inspired by our
journey. Utilize your understanding gained from the walk, supplemented by
relevant resources, to tackle this inquiry:
“In what ways did neoliberalism address Jeremy Bentham's principles of
laissez-faire and the Keynesian economic paradigm?”
You are required to use more materials and reference properly when choose
to answer this question.
[20 marks]
Part (3)
Question 6
You are required to solve the provided question and create a 3-to-5-
minute video demonstrating the solution. In your video, strive to
explain the solution in a clear and simple manner, presenting each
step sequentially. Ensure to mention the name of each part of the
solution for clarity. Utilize relevant diagrams and equations as
needed to enhance your explanation. Take the time to explain each
step thoroughly, providing a comprehensive understanding of the
solution. Remember, the goal is to make the solution accessible and
understandable to your audience.
The economy in Rivendell is initially at a long-run equilibrium. The Elvish central
bank decides to increase the money supply. Assuming any resulting inflation to be
unexpected, describe any changes in GDP, unemployment, and inflation that are
caused by the monetary expansion. Explain your conclusions using three diagrams:
one for the IS–LM model, one for the AD–AS model, and one for the Phillips curve.
In your explanations, consider the respective objectives and policy frameworks of
both central banks. Provide comprehensive analyses of the potential responses,
considering the implications for price stability, output, employment, and other
relevant factors. [20 marks]