Suppose that the economy is populated by two types of firms, firms with sticky prices and firms with flexible prices. These firms set their prices according to ps = EP, pf = P + a(Y-Y), where the superscripts and f denotes sticky and flexible price firms. Suppose the fraction of firms with sticky prices is equal to 0, meaning that 1 - 0 firms have flexible prices. Further, let a = 2 and 0 = 0.75. (a) Derive the short-run aggregate supply curve. Suppose that the natural rate of out- put is given by Y 100 and EP = 40. Plot the SRAS for output levels ranging from = 0 to 200. (b) Suppose that new technology reduces the fraction of firms with sticky prices from e=0.5. Is the new short-run aggregate supply curve steeper or flatter than the curve found in (a)? Plot this curve in the same diagram for the same values of P. (c) Suppose Okun's Law obeys a(Y – Ý) -p(u - u") where ß = = 3 and un = 5. Assume that the fraction of sticky price firms remains at = 0.5. Derive and plot this Phillips curve. = (d) Now suppose that expectations are formed adaptively so that Eπ = π_₁ and The Bank of Canada wants to reduce the inflation rate by 2%. What will happen to unemployment and output? What is the sacrifice ratio?²

Suppose the market supply curve is given by: Q=2P-4 and market demand by: 2-2 1-1. a) What is the value of Q when the market is equilibrium? Enter a number. b) P as a function of Q, i.e. find the inverse demand function. Your answer should be an algebraic expression in terms of Q without any decimals. Use a capital Q for Q and do not write "P="; just enter an expression in terms of Q. P= The variables found in your answer should be: [Q] c) Find the value of the consumer surplus when the market is equilibrium. Enter an algebraic expression, such as 3*In(4)-In(2)-8, rather than a decimal.

M3

Consider the market for a bond which has a face value of $2,000, pays a coupon of $100, and matures in 2 years. Suppose the demand for such bonds is given by P=2,900-Q, and that the original supply of such bonds is given by P=200+2Q. Suppose now that the supply of bonds is given by the equation P=500+2Q. If you bought the bond at the old equilibrium price (given the original supply curve), what would be your rate of return from selling the bond at the new equilibrium price (given the new supply curve)?     .1%     .05%     10%     5%