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The expectations augmented Phillips Curve has the form: π=π_^e- ε ( u- u^*). Suppose that currently in the economy we have, 〖∆M/M= π=π〗_^e=20%, 〖u=u〗^*=5% and some points along the expectations augmented Phillips Curve are illustrated in the table below.
Given the data in the table calculate the value of ε in the expectations augmented Phillips Curve.
The central bank would like to have, ∆M/M= π=0%. Illustrate the gradualist and cold-turkey approaches to getting inflation down using the Phillips Curve assuming adaptive expectations. In the case of the gradualist approach assume that ∆M/M is cut in two sets; first to 10% then to 0%. Identify the maximum unemployment rate that will be reached in the case of the cold-turkey approach.
For the case of cold turkey, how would the adjustment process you outlined above differ if economic agents had rational expectations? [Instructions: No diagrams should be used here. Explain your answer in words. Maximum 100 words. You must enter the word count of your answer.]
Question 2 (2 + 2 = 4 marks)
Suppose that the economy is at full employment and is hit by a negative supply shock such as a large rise in oil prices.
Illustrate this in an AD-AS diagram indicating the new level of prices and output.
Discuss and illustrate in an AD-AS diagram the short run and long run effects on the economy of the central bank adopting the following policies. [Instructions: Maximum 50 words. You must enter the word count of your answer.]
doing nothing
increasing the money supply
Question 3 (2 + 2 = 4 marks)
Suppose that Trumponomics—the economic policy of new President of the United States, Donald Trump—seems likely to involve cutting taxes and increasing government spending.
Illustrate what you think the effects of such a policy are likely to be on price and potential output in the long run using an AD-AS model in. [No discussion needed. Illustrate your diagram clearly.]
Discuss how the nature of the changes you illustrate in (a) will depend upon exactly what kind of tax cuts and spending increases are implemented. [Instructions: Maximum 150 words. You must enter the word count of your answer.]
Question 4 (2 + 2 + 2 = 6 marks)
In the following questions we are considering the neoclassical growth model.
In a diagram illustrate an economy in a steady state. Identify the steady state level of output per capita (y^*) and capital per capita (k^*). Also determine the growth rate in y, k, output (Y) and capital (K) at the steady state as a function of the model parameters; the savings rate (s), the population growth rate (n) and the depreciation rate (d). [Instructions: Maximum 100 words. You must enter the word count of your answer.]
Suppose there is an increase in the population rate to n^’>n. Illustrate the new steady state equilibrium for output per capita (y^*), capital per capita (k^*) relative to that in (a). Also determine the growth rate in y, k, Y and K at the steady state as a function of the model parameters compared with that in (a). [Instructions: Maximum 100 words. You must enter the word count of your answer.]
Given your answer in (b) comment on the effectiveness of population growth as a driver of increases in the steady state output per capita. Discuss other factors which could lead to rises in steady state output per capita in the neoclassical growth model. [Instructions: No diagram should be used here. Maximum 200 words. You must enter the word count of your answer.]
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