Question 1
NOTES: For this question, you want to use a medium-run aggregate supply curve as opposed to a short-run supply curve. Please draw a large enough set of diagrams so that your answers to all parts of this question fit
on them.
a) Let us return to 2019. Assume that the US economy is in its long-run equilibrium. Use ADAS and Phillips Curve diagrams to illustrate the equilibrium and label it (1). As always, label all axes, curves, and write model equations.
b) Illustrate the effects of the COVID pandemic on the US economy assuming that the pandemic brought about
a negative demand shock. Label new equilibrium (2) and comment on how macroeconomic variables have
changed as compared to part A.
c) Suppose that the Fed announces its decision to engage in massive bond purchases. This step has some
effect but does not restore the economy to the pre-recessionary level. Illustrate short-run effects of the Fed’s
policy on the U.S. economy using your ADAS and Phillips curve graphs. Label the equilibrium (3) and describe
the economic intuition.
d) Next, suppose that the negative economic effects of the COVID recession are so persistent that
policymakers believe extra stimulus is needed. The Fed continues its expansionary monetary policy and so
that the natural rate of output is surpassed. Again, illustrate short-run effects of the Fed’s policy action on the
U.S. economy on both ADAS and Phillips curve diagrams and describe how and why the new equilibrium (4) is different from the equilibrium (3).
e) According to the rational expectations Phillips curve model, what would happen to the US economy in the long run? Use the Phillips curve diagram and Phillips curve equation to illustrate adjustment from the old
equilibrium (4) to the new equilibrium (5). Describe the intuition. To be clear, you do not need to use the ADAS model for part E.
BONUS: Illustrate your answer to part E on your ADAS model diagram. Explain the intuition for your result.
Question 2.
Statistical data show an impressive positive growth trend in South Korea between 1970 and 2020. Economists
adopted the Solow model for the analysis of the Korean growth miracle and argued that capital accumulation and technological progress drove the growth process.
a) Draw a (large enough) Solow model diagram for the economy of South Korea in 1970. Label per person output, investment, and depreciation functions and write formulas for each function you plotted. Assuming the
country’s capital stock was below the golden-rule capital stock level in 1970, label it as kstst.
b) Illustrate the effects of a saving rate increase that took place between 1970 and 2020 in the Korean
economy. Assume that the golden-rule steady state level of capital was reached and label it kgr. Describe how
key macroeconomic variables have changed relative to part A.
c) Explain how you found the golden-rule capital stock and why it is called so.
d) Next, show effects of technological progress on the economy. Assume Korea achieves the golden-rule
steadystate again and comment on changes between parts B and D.
BONUS: Why did not the economists mention monetary policy as a driver of economic growth in Korea between
1970 and 2020? If you were to include monetary policy in your analysis, how would your Solow diagram change?

Sample Solution