Economics 219

Problem Set #6

1.    Assuming prices are fully flexible, explain each of the following events using the IS-LM-FE framework. Assume that prices are fully flexible.
  1. Computerization improves labor productivity in the United States.
  2. The Fed increases the money supply by 10%.
  3. Consumer confidence falls, causing consumers to save more.
2.    Suppose that the government initiates a program to deregulate the utilities industry (i.e., electricity, natural gas, etc.). The effect of this program is an increase in the productivity of capital equipment. For simplicity, you can assume that this increase in the productivity of capital is immediate and is expected to be permanent.

     a. Analyze the immediate impact of the program on output, investment, consumption, employment, interest rates, and the real wage. (Remember that it takes time to install new capital goods!)

    b. Analyze the impact of this program once enough time has passed that any new capital purchases have been installed.

3.    In the 1970’s, the U.S. was in the midst of a recession. Output was down and unemployment was at 6%. Nixon, undoubtedly looking towards the 1972 election decided that a new "game plan" was needed to boost the economy without worsening inflation. His solution was a temporary freeze on prices along with an expansionary monetary policy. During the price freeze, output rose by 5% and unemployment fell (Nixon won the ’72 election in a landslide). However, after the price controls were lifted, output fell and prices skyrocketed. How would you explain the apparent success and ultimate demise of this policy?

4.    Suppose that a majority of the U.S. labor force is under a wage contracts that are renegotiated yearly.

  1. What would be the immediate effect of a monetary contraction by the Federal Reserve?
  2. What would be the long run effects (i.e. greater than one year)?