ECO104 Second assignment Marks: 25

Course faculty: Humaira Husain (Sr. Lecturer, Econ dept. NSU)

Sec:______15_______

Fill in the gaps with appropriate word or words. (10 Marks)

Q1. A) Steady state unemployment rate depends on rate of Job separation and rate of job

____Findings _________.

B) If the rate of job separation is constant, rate of job finding rises, natural rate of unemployment

____falls________.

C) Sectoral shift is responsible for __ frictional_ unemployment.

D) The information regarding ability of the worker is not ____ distinguish________ between
employer and employees, and this creates adverse selection problem.

E) Structural unemployment problem arises because there is _____conflict __ between

labour demand and labour supply.

F) Minimum wage law should not ____essentially__ be exempted for teenagers.

G) Price is ____ rigid _______ in short run and _ flexible ___ in the long run.

H) Unions and collective bargaining is one of the reasons for wage ___ raising_.

I) Moral hazard problem is related to the ___higher__ level of the worker.

J) Aggregate demand curve shows _____negative_____________ proportional relationship

between Price and Output.

Q2. Write short notes on the followings: Add diagram if needed. (10 Marks)

Adverse Selection: According to Mankiw’s textbook adverse selection is an unfavorable

sorting of individuals by their own choices; for example, in efficiency-wage theory, when a wage
cut induces good workers to quit and bad workers to remain with the firm.

A third efficiency-wage theory holds that the average quality of a firm’s work force
depends on the wage it pays its employees. If a firm reduces its wage, the best employees may
take jobs elsewhere, leaving the firm with inferior employees who have fewer alternative
opportunities. Economists recognize this unfavorable sorting as an example of adverse selection.
By paying a wage above the equilibrium level, the firm may reduce adverse selection, improve
the average quality of its workforce, and thereby increase productivity.

a) Effectiveness of monetary policy in the short run

In short run If Central Bank increases the money supply the downward sloping AD curve
shifts towards the right. Equilibrium output rises but the price level is unchanged. In
expansionary monetary policy it is successful in increasing the output level. The output level
goes right from Y1 to Y2 but it doesn’t have any impact on the price level. So, we can say it does
have impact on Y but no impact on P(price)
 On the other hand, If Central Bank decreases the money supply the downward sloping AD
curve shifts towards the left. Equilibrium output falls but the price level is unchanged. In
contractionary monetary policy leads to decrease in output level without having no change in
price. Output level decrease from Y1 TO Y2 and it doesn’t have any impact in price level. The
equilibrium moves to E2 FROM E1.

Equation:

M.V = P.Y …(I)

We, consider time frame in short run: We consider P to be constant at Ṕ. We also consider
Velocity to be constant at V´ . We substitute these in equation (1).

M. V́ = Ṕ .Y …….. (Ia)

We observe directly proportional relationship between M and Y. This means if M rises by 2%, Y
also rises by 2%. On the other hand, if M (money) supply reduces by 2% Y also reduces by 2%.

Graph also confirms the same result. In short run Money supply is effective in raising output
Q3. How do you differentiate long run aggregate supply curve form short run aggregate supply

curve? (Add picture if needed) (5 Marks)

Answer: The long run aggregate supply curve is a vertical curve on the other hand the
short run aggregate supply curve is a horizontal curve. In these two curves the price behaves
differently.

In the long run, the price is flexible and the movement of price happening rapidly. In here
the level of output is determined by the amounts of capital and labor and by the available
technology; it does not depend on the price level.

However, in the short run, the price is not that much flexible it is rigid and movement of
price becomes sluggish. Because the labor supply is perfectly elastic in here and the firm faced
menu cost and because of this menu cost the firm faces time lag. This is responsible to make the
price rigid in short run.

From these two graph we see that, in the left panel we have SARS a horizontal line. In
here the price is rigid. The fixed price is OP’’ , at this price level as a producer he/she can
produce either OY1 (recruiting lower number of workers) or OY2 (recruiting higher number of
workers).

In the right panel we have LRAS that is simply vertical at the special/Natural level of
output. 0𝑌 ̅= Natural level of output. This is amount of output economy can produce if it utilizes
all its existing resources (Land, skilled labor and capital: physical and human).