4. Oil price shocks. Suppose the economy is initially at a medium-run equilibrium (defined by Y₁, Un, and rn). Consider the effect of a rise in oil prices, modelled as a rise in firm markups (m). As we move from a medium-run equilibrium to a short-run equilibrium (caused by the increase in m), i. ii. iv. V. Demonstrate, using a figure, the effect on the WS and PS curves. How does this affect the natural rate of unemployment? vii. What is the effect, in the short run, on nominal wages (W), prices (P), real wages (W/P), and price expectations (P)? Demonstrate, using a figure, the short-run effect on the PC relation. If the economy is to return to having a zero output gap, how must the central In the new medium-run equilibrium, how does equilibrium output and the level of inflation compare to that in the initial medium-run equilibrium? What do we call this phenomenon? vi. Now suppose that the rise in oil prices also had a direct (adverse) effect on firm investment: let firm investment be defined by I(Y,r+x,m), where investment is decreasing in firm markups. Demonstrate, using figure(s), the short-run effect on both the PC relation and the IS curve. Be careful when depicting the possible cases for the level of short- run equilibrium output and its relation to medium-run equilibrium potential output - there will be multiple cases, depending on the relative shifts to the PC and IS curves. If the economy is to return to having a zero output gap, how must the central bank adjust the real interest rate?
4. Oil price shocks. Suppose the economy is initially at a medium-run equilibrium (defined by Y₁, Un, and rn). Consider the effect of a rise in oil prices, modelled as a rise in firm markups (m). As we move from a medium-run equilibrium to a short-run equilibrium (caused by the increase in m), i. ii. iv. V. Demonstrate, using a figure, the effect on the WS and PS curves. How does this affect the natural rate of unemployment? vii. What is the effect, in the short run, on nominal wages (W), prices (P), real wages (W/P), and price expectations (P)? Demonstrate, using a figure, the short-run effect on the PC relation. If the economy is to return to having a zero output gap, how must the central In the new medium-run equilibrium, how does equilibrium output and the level of inflation compare to that in the initial medium-run equilibrium? What do we call this phenomenon? vi. Now suppose that the rise in oil prices also had a direct (adverse) effect on firm investment: let firm investment be defined by I(Y,r+x,m), where investment is decreasing in firm markups. Demonstrate, using figure(s), the short-run effect on both the PC relation and the IS curve. Be careful when depicting the possible cases for the level of short- run equilibrium output and its relation to medium-run equilibrium potential output - there will be multiple cases, depending on the relative shifts to the PC and IS curves. If the economy is to return to having a zero output gap, how must the central bank adjust the real interest rate?
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Only answer v, vi, vii please
Transcribed Image Text:4. Oil price shocks.
Suppose the economy is initially at a medium-run equilibrium (defined by Y, un, and ra).
Consider the effect of a rise in oil prices, modelled as a rise in firm markups (m). As we move
from a medium-run equilibrium to a short-run equilibrium (caused by the increase in m),
Demonstrate, using a figure, the effect on the WS and PS curves. How does this
affect the natural rate of unemployment?
What is the effect, in the short run, on nominal wages (W), prices (P), real wages
(W/P), and price expectations (P*)?
i.
ii.
iii.
Demonstrate, using a figure, the short-run effect on the PC relation.
If the economy is to return to having a zero output gap, how must the central
iv.
In the new medium-run equilibrium, how does equilibrium output and the level
of inflation compare to that in the initial medium-run equilibrium? What do we
call this phenomenon?
Now suppose that the rise in oil prices also had a direct (adverse) effect on firm investment:
let firm investment be defined by I(Y,r+x,m), where investment is decreasing in firm markups.
vi.
Demonstrate, using figure(s), the short-run effect on both the PC relation and
the IS curve. Be careful when depicting the possible cases for the level of short-
run equilibrium output and its relation to medium-run equilibrium potential
output – there will be multiple cases, depending on the relative shifts to the PC
and IS curves.
vii.
If the economy is to return to having a zero output gap, how must the central
bank adjust the real interest rate?
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