BCOR240 Fall 2019-2020– Week starting December 2nd 2019.

Fifth Tutorial
The Economic Fluctuations
(Please note that The Unemployment Chapter will be covered by Homework II)
A- Use the text below to estimate the Tunisian Okun’s law. Note that potential growth refers to
the long run real GDP growth or full employment or natural growth.

Source: IMF Country Report for Tunisia, June 2018.

“The Challenge of Raising Growth to Reduce Unemployment.
Cutting unemployment by one-fourth requires 5 percent real GDP growth, sustained over five years.
This estimate shows the order of magnitude of Tunisia’s economic most important challenge. This
challenge is made harder by the country’s strong labor force growth (projected at an annual 1.5 percent
of GDP by the Tunisia Statistic Institute) and a comparatively low elasticity of jobs creation to growth
(assumed in a range between 0.36 and to 0.50, with the boundaries being the values for Morocco and
the MENA region, respectively)…
... Accelerated reforms and decisive policies are needed to stabilize the economy. Growth could pick up
to 2.4 percent in 2018 and then gradually approach its potential of 4 percent. Tighter fiscal and
monetary policies are needed to reduce inflation and debt—with continued exchange rate flexibility—
to rebuild international reserves…
The unemployment rate remains high at 15 percent, especially affecting the youth, women, and the
population of the interior regions….”

B- The 2017 Nobel Prize winner in economic sciences relaxed the simplifying assumptions of
rational behavior for economic agents to include cognitive/psychological limitations, self-
control problems and social/cultural constraints.

As textbooks for undergraduate students -around the world- are not yet adapted to such novel approach,
you do still believe that the standard rational approach of AD-AS learned in class provides valuable
solutions to the following real life problems.
I.1 The black market in Tunisia
The illegal transactions in goods and services are mostly done in cash because it changes hands without
leaving a trace. Therefore, a cash-free society helps to constrain black markets.
I.1.1 State the quantity equation as aggregate demand (define the involved variables and
provide their units). Plot the aggregate demand using the relevant variables.
I.1.2 As a first step for moving to a cash-free Tunisia, the Central Bank decides to demonetize
all the 20 TND paper bills which is expected to cancel 45% of the value of cash in circulation.
Plot the impact of such policy in the short run and in the long run assuming that it only shocks
negatively the aggregate demand. What are the effects in the short run and in the long run on
output, unemployment and price level?
I.1.3 In order to accommodate the negative shock of I.1.2 in the short run, what is the
stabilization policy that you recommend? Plot a graph detailing the effects of a monetary or a
fiscal policy of your choice. What is the cost of the stabilization policy that you suggest?
I.1.4 Assume that the shock described in I.1.2 also increases the long run supply function of
1.1 (Exercise 1) by doubling the long-run technology parameter AT. Plot the cumulated impact
of the AD shift and the long run AS shift. What are the cumulated effects in the short run and
in the long run on output, unemployment and price level?
I.2 The Israeli-Palestinian conflict
In early December 2017, Donald Trump announced that he plans to move the USA Embassy from Tel
Aviv to Jerusalem, and that the USA will recognize Jerusalem as the capital of Israel.
If such shock to the peace process happens, discuss the impact on the Palestinian economy in the short
run and in the long run using the AD-AS model. Argue why you would consider this negative shock as
hitting aggregate demand only, aggregate supply only, or both. Provide a graph.