# Midterm 2 with Solutions Econ311

**Topics:**Inflation, Monetary policy, Unemployment

**Pages:**16 (3687 words)

**Published:**November 19, 2012

Final Examination Fall, 2009

YOUR NAME:________________________________

INSTRUCTIONS

1. The exam lasts 2 hours.

2. The exam is worth 120 points in total: 30 points for the multiple choice questions, 60 points for the analytical questions, and 30 points for the essays. 3. Write your answers to Part A (the multiple choice section) in the blanks on page 1. You won’t get credit for circled answers in the multiple choice section. 4. Place all of your answers for part B in the space provided. 5. You must show your work for part B questions.

6. Write your essays with a pen. Write clearly!

7. Good Luck and Happy Holidays!

PART A (45 points)

Choose the ONE alternative that BEST completes the statement or answers the question. Your answers must be in the space provided below.

USE CAPITAL LETTERS.

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PART B (45 points)

Please show your work and write down the formulas you use for partial credit.

Question 1 (5 points)

(a) What monthly rate of inflation causes the price level to increase by a factor of 5 (500 percentage points) over a year? (2 points) (HINT: Use the LN and EXP formulas from Chapter 9, Problem 2, further examples of which were presented in lecture on November 11).

Using the log formula:

p = 100*log(5)/12 = 13.4%.

(b) If the rate of monthly inflation is 25%, by what factor would prices have risen over a year? (3 points)

Let’s call the initial price level P0 and the price level at the end of the year P12

25 = 100*log(P12/P0)/12

P12/P0 = exp(25*12/100) = 20.

Question 2 (10 points)

Consider an economy where inflation expectations are given by the equation pet = .4 pt-1 + .6 pet-1 .

Also assume that when the log of the output ratio increases by 1 points, inflation increases by 4 points. a) Write down the SP equation, both its general form and its specific form with these particular parameter assumptions inserted. (2 points)

pt = pet + gŶt-1 + zt = .4pt-1 + .6pet-1 + 4Ŷt-1 + zt

b) Write down the DG equation (no need to derive anything, just write it down). (1 point)

Ŷ = Ŷ-1 + [pic] - p

c) Combine the SP and DG equations to express p as a function of pt-1, pet-1, Ŷt-1,[pic]t, and zt. (2 points) (HINT: Your answer must have p on the left side of the equation and terms not including current p on the right side, with all the relevant parameters inserted and solved out.)

p = 0.4p-1 + 0.6pe-1 + 4Ŷ + z = 0.4p-1 + 0.6pe-1 + 4(Ŷ-1 + [pic] - p) + z

5p = 0.4p-1 + 0.6pe-1 + 4Ŷ-1 + 4[pic] + z

p = 0.08p-1 + 0.12pe-1 + 0.8Ŷ-1 + 0.8[pic] + z

For the remainder of the problem, assume that in period t=1 the economy has values given by: p0 = 3pe0 = 3Ŷ0 = 0

d) Suppose there is no supply shock in period 1 (z1 = 0) and that [pic]1 = 5. Solve for period 1 values p1 and Ŷ1. (2 points)

p1 = 0.08(3) + 0.12(3) + 0.8(0) +...

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