Part 1

Question 1: (40 points) Use the social planner diagram to show the effects of a decrease in the total factor productivity on consumption and labor supply . Describe the effects. What happens with output ?

Question 2: (40 points) Assume there is a government whose spending is unproductive and financed through lump-sum taxes . Use the social planner diagram to show the effects of an increase in government spending on output and labor supply . Describe the effects.

Question 3: (10 points) Use your answers to questions 1 and 2 to analyze the following statement: "Economic recessions are caused by negative shocks in total factor productivity. The government can foster an economic recovery (increase output) by increasing government spending. This type of policy would improve the welfare of individuals in the economy." Which sentences in the statement above are true and which sentences are false (according to your analysis in questions 1 and 2)? Explain.

Question 4: (10 points) Suppose government spending is financed through proportional taxes levied on profits. In other words, = such that the representative firm retains (1 ) of the profits . Is the competitive equilibrium allocation in this economy a Pareto optimum allocation? Explain.

Part 2

Question 1 (50 points):

Recall that a positive shock in current TFP increases real GDP and decreases the real interest rate. Use the money market graph to show the effect of this shock on the demand for money and the price level. What is the adequate monetary policy to maintain the price level stable?

Question 2 (30 points): Suppose that the central bank can influence people's expectations about inflation through public speeches. Use the money market graph to show the effect of lowering expected inflation on prices. Hint: Recall that the demand for money is = (, ) = (, + ), where is expected inflation.

Question 3 (20 points): Suppose the economy is in the liquidity trap. Let be split into short-term bonds (considered close substitutes to money) and long-term bonds . Draw the money market and show the effect of an expansionary monetary policy through conventional open market purchase of government debt. Explain how the FED would perform quantitative easing in this situation. How would that change the composition of ?

Question 1: (40 points) Use the social planner diagram to show the effects of a decrease in the total factor productivity on consumption C and labor supply N*. Describe the effects. What happens with output Y? Question 2: (40 points) Assume there is a government whose spending G is unproductive and financed through lump-sum taxes T. Use the social planner diagram to show the effects of an increase in government spending G on output Y and labor supply N*. Describe the effects. Question 3: (10 points) Use your answers to questions 1 and 2 to analyze the following statement: \"Economic recessions are caused by negative shocks in total factor productivity. The government can foster an economic recovery (increase output) by increasing government spending. This type of policy would improve the welfare of individuals in the economy.\" 'Which sentences in the statement above are true and which sentences are false (according to your analysis in questions 1 and 2)? Explain. Question 4: (10 points) Suppose government spending is financed through proportional taxes levied on profits. In other words, G = T X 7 such that the representative firm retains (1 7) of the profits 7. Is the competitive equilibrium allocation in this economy a Pareto optimum allocation? Explain. zooM + 2 Question 1 (50 points): Recall that a positive shock in current TFP increases real GDP and decreases the real interest rate. Use the money market graph to show the effect of this shock on the demand for money and the price level. What is the adequate monetary policy to maintain the price level stable? Question 2 (30 points): Suppose that the central bank can influence people's expectations about inflation through public speeches. Use the money market graph to show the effect of lowering expected inflation on prices. Hint: Recall that the demand for money is M = PL(Y,R) = PL(Y,r + i), where i is expected inflation. Question 3 (20 points): Suppose the economy is in the liquidity trap. Let B be split into short-term bonds BS (considered close substitutes to money) and long-term bonds BX. Draw the money market and show the effect of an expansionary monetary policy through conventional open market purchase of government debt. Explain how the FED would perform quantitative easing in this situation. How would that change the composition of B? zooM + 2