Unit 4 Discussion: Exploring your thoughts on mental illness and recovery Topic: David Rosenhan's "On Being Sane In Insane Places" and psychiatric diagnoses. Background: "In the early 1970's, David Rosenhan decided to test how well psychiatrists were actually able to distinguish the "sane" from the "insane." Psychiatry, as a field, is, of course, predicated upon the belief that its own professionals know how to reliably diagnose aberrant mental conditions, and to make judgments based on those diagnoses about a person's social suitability – performance as a parent, parolee's flight-risk, and prisoner's ability to be reformed. Rosenhan was conscious and critical of the huge amount of social control psychiatrists had, so he devised an experiment to test whether their actual skills were on par with their power. He recruited eight other people, and together they faked their way into various mental institutions, and then, once on the ward, acted completely normally. The goal: to see whether the psychiatrists would detect their sanity, or whether the psychiatrists' judgments would be clouded by presuppositions (i.e., if the patient is there, labeled a patient, then he must be crazy). Rosenhan's experiment elegantly explores the way the world is always warped by the lens we are looking through, and, by doing so, he raised critical questions about not only the possibility of "objective" psychiatry, but of "objective" life." (Slater, 2004). Source: Slater, L. (2004) Opening Skinner's Box: Great Psychological Experiments of the Twentieth Century. For more information on the study: http://psychrights.org/articles/rosenham.htm Source: David L. Rosenhan, "On Being Sane in Insane Places," Science, Vol. 179 (Jan. 1973), 250-258. Additional Information: MyPsychLab – WATCH Episode 17 Psychological Disorders and Therapies Living with a Disorder Basics http://visual.pearsoncmg.com/mypsychlab/index.php?clipId=99 Discussion Question When David Rosenhan asked mock "patients" to infiltrate a mental facility he found that they had some difficulty in getting back out. After mental health professionals had labeled these individuals as "schizophrenic" they had a difficult time seeing the normalcy of the patient's behaviors. It is nonetheless true, though, that diagnosis and identification of mental disorders aids in developing a prognosis and treatment plans for those experience psychological conflict and/or disturbances. 1. Do diagnostic labels hinder or enhance treatment? How so? 2. Can people with mental disorders escape the potentially harmful consequences of being labeled "sick" or "mentally ill"? 3. Do those diagnosed and labeled have the right to keep their diagnosis private? From whom? In what circumstances should that right be disregarded? 4. Would knowing an acquaintance had a diagnosable psychological disorder change your perception of them? Family member? Potential spouse? How so? 5. Randomly select a diagnostic label from the chapter (please do not ch ...

1. Unit 4 Discussion: Exploring your thoughts on mental illness
and recovery
Topic: David Rosenhan's "On Being Sane In Insane Places" and
psychiatric diagnoses.
Background: "In the early 1970's, David Rosenhan decided to
test how well psychiatrists were actually able to distinguish the
"sane" from the "insane." Psychiatry, as a field, is, of course,
predicated upon the belief that its own professionals know how
to reliably diagnose aberrant mental conditions, and to make
judgments based on those diagnoses about a person's social
suitability – performance as a parent, parolee's flight-risk, and
prisoner's ability to be reformed. Rosenhan was conscious and
critical of the huge amount of social control psychiatrists had,
so he devised an experiment to test whether their actual skills
were on par with their power. He recruited eight other people,
and together they faked their way into various mental
institutions, and then, once on the ward, acted completely
normally. The goal: to see whether the psychiatrists would
detect their sanity, or whether the psychiatrists' judgments
would be clouded by presuppositions (i.e., if the patient is
there, labeled a patient, then he must be crazy). Rosenhan's
experiment elegantly explores the way the world is always
warped by the lens we are looking through, and, by doing so, he
raised critical questions about not only the possibility of
"objective" psychiatry, but of "objective" life." (Slater, 2004).
Source: Slater, L. (2004) Opening Skinner's Box: Great
Psychological Experiments of the Twentieth Century.
For more information on the
study: http://psychrights.org/articles/rosenham.htm
Source: David L. Rosenhan, "On Being Sane in Insane
Places," Science, Vol. 179 (Jan. 1973), 250-258.
Additional Information: MyPsychLab – WATCH Episode 17
Psychological Disorders and Therapies Living with a Disorder
Basics http://visual.pearsoncmg.com/mypsychlab/index.php?clip

2. Id=99
Discussion Question
When David Rosenhan asked mock "patients" to infiltrate a
mental facility he found that they had some difficulty in getting
back out. After mental health professionals had labeled these
individuals as "schizophrenic" they had a difficult time seeing
the normalcy of the patient's behaviors. It is nonetheless true,
though, that diagnosis and identification of mental disorders
aids in developing a prognosis and treatment plans for those
experience psychological conflict and/or disturbances.
1. Do diagnostic labels hinder or enhance treatment? How so?
2. Can people with mental disorders escape the potentially
harmful consequences of being labeled "sick" or "mentally ill"?
3. Do those diagnosed and labeled have the right to keep their
diagnosis private? From whom? In what circumstances should
that right be disregarded?
4. Would knowing an acquaintance had a diagnosable
psychological disorder change your perception of them? Family
member? Potential spouse? How so?
5. Randomly select a diagnostic label from the chapter (please
do not choose Neurodevelopmental disorders (Autism Spectrum
disorders, Dyslexia, ADHD, ADD), list the specific behaviors,
cognitions, and qualities needed to diagnosis this disorder. How
do you think you would feel if you were diagnosed with this
disorder? How would you cope? How might it affect your
family?
6. Research and share one therapy utilized to treat the disorder
you selected. How does someone determine the most
appropriate form of therapy? Share at least one supportive

3. resource available to individuals suffering from the disorder
you explored. For more information in Therapy & Mental
Illness watch MyPsychLab: Episode 17 Psychological Disorders
and Therapies Therapies in Action
Basicshttp://visual.pearsoncmg.com/mypsychlab/index.php?clip
Id=99
Please note that I am looking at two distinct areas when grading
your discussions: First, I am looking at the objective criteria
and looking to see how many posts you have completed.
Second, more importantly, I am looking at the subjective
criteria and closely examining the quality of your posts.
Homework Week 6 Answers
The homework is worth 20 points, so each answer will have
points distribution at the
instructor’s discretion.
Chapter 14
1. a. Given that the interest rate has been 4 percent for the last
ten quarters, then for IS curve
I, real GDP equals 8,800 − 25(4) − 25(4) − 25(4) − 25(4) −
20(4) − 20(4) − 20(4) −
15(4) − 15(4) −
10(4) = 8,000. For IS curve II, real GDP equals 8,400 − 5(4) −
5(4) − 5(4) − 5(4) − 10(4)
−
15(4) − 15(4) − 15(4) − 20(4) = 8,000.

4. b. For IS curve I, real GDP in the first quarter equals 8,800 −
25(3) − 25(4) − 25(4) − 25(4)
−
20(4) − 20(4) − 20(4) − 15(4) − 15(4) − 10(4) = 8,025. Using
the same IS curve, it is
easy to show that for quarters two through ten, real GDP equals
8,050, 8,075, 8,100,
8,120, 8,140,
8,160, 8,175, 8,190, and 8,200, respectively. For IS curve II,
real GDP in the first
quarter equals 8,400 − 5(3) − 5(4) − 5(4) − 5(4) − 5(4) − 10(4)
− 15(4) − 15(4) − 15(4) −
20(4) = 8,005. Using the same IS curve, it is easy to show that
for quarters two through
ten, real GDP equals 8,010, 8,015, 8,020, 8,025, 8,035, 8,050,
8,065, 8,080, and 8,100,
respectively.
c. Real GDP increases by 200 billion for IS curve I. The
increase in real GDP for IS curve
II equals 100 billion.
d. For IS curve I, it takes four quarters, or twelve months, for
real GDP to increase by 100
billion or one-half of the total increase in real GDP. For IS
curve II, it takes seven
quarters, or twenty-one months, for real GDP to increase by 50
billion or one-half of the
total increase in real GDP.
e. IS curve I resembles the economy’s response prior to 1991.
The increase in output in
response to a decline in the interest rate is larger than for IS
curve II and one-half of the
total increase in output occurs much sooner with IS curve I as

5. compared to IS curve II.
IS curve II resembles the economy’s response to a change in the
interest rate since 1991.
The reasons why IS curve I resembles the economy’s response
prior to 1991 is that its
interest rate parameters for the first six quarters are larger than
those of IS curve II, and
it is only for that last quarter that IS curve I has a smaller
interest rate parameter than
that of IS curve II. These parameters reflect the fact that since
1991, the monetary policy
effectiveness lag has been longer and the interest-rate multiplier
has been smaller.
f. The answers to Parts b through d indicate that for IS curve II,
real GDP rises less than it
does for IS curve I during any of the first seven time periods,
for any given increase in
the interest rate. Therefore, the changes in the policy
effectiveness lag and the interest-
rate multipliers mean that monetary policymakers now have to
change interest rates
more in response to a given demand shock than they did
previously.
Chapter 17
2. a. The equation for the aggregate demand curve is Y = 9,000
+ 3,000/P, given that the
nominal money supply is initially 3,000. If the price level
equals 0.8, the point on the
aggregate demand curve is Y = 9,000 + 3,000/0.8 = 9,000 +
3,750 = 12,750. The same
calculation shows that the following points are on the aggregate
demand curve: (12,000,
1.0), (11,500, 1.2), (11,400, 1.25), and (11,000, 1.5).

6. b. The long-run equilibrium values of real GDP and the price
level are where aggregate
demand and long-run aggregate supply are equal. Long-run
equilibrium also requires the
price level to equal the expected price level or equivalently that
the price surprise is
zero. Since the long-run aggregate supply curve is vertical at
natural real GDP and since
natural real GDP equals 12,000, the long-run equilibrium values
of real GDP and the
price level are also 12,000 and 1.0, given that the expected
price level is initially 1.0.
c. The decrease in the real exchange results in an increase in
aggregate demand so that the
new equation for the aggregate demand curve is Y = 9,600 +
3,000/P, given the initial
value of the nominal money supply. Therefore, if the price level
equals 0.8, the point on
the new aggregate demand curve is Y = 9,600 + 3,000/0.8 =
9,600 + 3,750 = 13,350. The
same calculation shows that the following points are on the new
aggregate demand
curve: (12,600, 1.0), (12,100, 1.2), (12,000, 1.25), and (11,600,
1.5).
The new level of aggregate demand and short-run aggregate
supply are equal at real
GDP equal to 12,100 and a price surprise equal to .2. Therefore,
the new equilibrium
price level equals 1.2 in the short run.
d. If monetary policymakers respond to the decline in the real
exchange rate by doing

7. nothing and leaving the nominal money supply at its current
level of 3,000, then the
long-run equilibrium price level is 1.25, since that is where
aggregate demand and the
long-run aggregate supply are equal at the natural real GDP
level of 12,000.
If monetary policymakers change the money supply so as to
return the price level to 1.0,
which is what it was equal to in Part b, then the nominal money
supply, M s, must be
such that 12,000 = 9,600 + M s/1.0 or M s = 12,000 − 9,600 =
2,400. That is, monetary
policymakers must reduce the nominal money supply to 2,400
for the price level and the
expected price level to be equal at P = 1.0.
If monetary policy changes the money supply so as to keep the
price level equal to 1.2,
which is what it was in Part c, then the nominal money supply,
M s, must be such that
12,000 = 9,600 + M s/1.2 or M s/1.2 = 12,000 − 9,600 = 2,400.
Therefore, M s =
1.2(2,400) = 2,880. That is, monetary policymakers must reduce
the nominal money
supply to 2,880 for the price level
and the expected price level to be equal at P = 1.2.
3. a. If the decline in the real exchange rate is only temporary,
so that the aggregate demand
curve returns to its original level, then given no change in the
nominal money supply,
the economy is long-run equilibrium when the expected price
level and the actual price
level at 1.0.
On the other hand, if monetary policymakers change the
nominal money supply so as to
maintain a price level equal to 1.2 when aggregate demand

8. returns to its original level,
then they must change the nominal money supply to M s′so that
12,000 = 9,000 + M s′/1.2
or M s′/1.2 = 12,000 − 9,000 or M s′ = 1.20(3,000) = 3,600.
That is, monetary
policymakers would have to increase the nominal money supply
to 3,600 to keep the
price level and expected price level equal to 1.2.
b. If monetary policymakers do nothing in the sense of not
changing the nominal money
supply, then expected and actual price level rise if the decline
in the real exchange rate
persists. The reason both price levels rise is that firms and
workers know it takes a
higher price level to offset the increase in aggregate demand
caused by the decline in the
real exchange rate, given that they expect monetary
policymakers to take no steps to
offset that increase in aggregate demand. On the other hand, if
firms and workers know
that the decline in the real exchange rate is only temporary, then
they understand that the
increase in aggregate demand is also only temporary. So if they
expect that monetary
policymakers are not going to take any steps to respond to the
temporary changes in the
real exchange rate and aggregate demand, then they also know
that the price level
returns to 1.0, so that is the price level they expect.
Note, however, that if the decline in the real exchange rate is
expected to persist, so that
the increase in aggregate demand is also expected to persist and

9. firms and workers also
expect monetary policymakers to take actions to reduce the
price level to 1.0 in the face
of that increase in aggregate demand, then monetary
policymakers must reduce the
nominal money supply enough to shift the aggregate demand
curve back to its original
level.
Finally, if firms and workers expect that monetary policy
makers will maintain the price
level at 1.2, then when the decline in the real exchange rate is
expected to persist,
monetary policymakers must take action so as to reduce
aggregate demand so that
aggregate demand and long-run aggregate supply are equal to
12,000 at a price level of
1.2. That reduction in aggregate demand would require a
decrease in the nominal money
supply. On the other hand, if the decline in the real exchange is
only temporary and so
also is the increase in aggregate demand, then monetary
policymakers would have to
increase aggregate demand so as to keep aggregate demand and
long-run aggregate
supply equal to 12,000 at a price level of 1.2. That would
require an increase in the
nominal money supply.
c. Policymakers, workers, and firms would look to data from the
foreign exchange markets
and economic conditions in the rest of the world in an attempt
to determine if there were
changes in any of these areas that would cause the decline in the
real exchange rate to
either persist or only be temporary in nature.
If monetary policymakers have always responded to changes in

10. aggregate demand by
not doing anything, then there is nothing that they can do to
signal to workers and firms
whether the change in the real exchange rate is going to persist
or is only temporary. On
the other hand, if monetary policymakers have responded to
changes in aggregate
demand so as to either maintain the price level at its pre- or
post-surprise level, then
what they do to the nominal money supply signals to firms and
workers what they have
discovered concerning the nature of change in the real exchange
rate. For example, if
workers and firms expect that monetary policymakers act so as
to maintain the price
level equal to 1.0, its pre-surprise level, then monetary
policymakers
can signal to workers and firms that the decline in the real
exchange is only temporary
by maintaining the nominal money supply at its pre-surprise
level. On the other hand, if
monetary policy makers discover that the decline in the real
exchange rate is going to
persist, then they can signal that to workers and firms by
reducing the nominal money
supply. Finally, you should be able to figure out how monetary
policymakers can signal
to firms and workers what they know about the change in the
real exchange rate via a
change in the nominal money supply if workers and firms
expect monetary
policymakers to maintain the price level at 1.2.
WEEK 6

11. CH14, Problem 1 – You are given the following two IS curves
that show how real GDP (Yt) in the current time period t
depends on the current interest rate and interest rates in
previous periods, where rt is the interest rate in time period t.
Furthermore each time period corresponds to a quarter or three
months.
1. Yt= 8800-25Rt-25Rt-t
- 25Rt-2 - 25Rt-3 - 20Rt-4 - 20Rt-5
- 20Rt-6 - 15Rt-7 - 15Rt-8 - 10Rt-9
2. Yt= 8400 - 5Rt - 5Rt-1
- 5Rt-2 - 5Rt-3 - 5Rt-4 - 10Rt-5
- 15Rt-6 - 15Rt-7 - 15Rt-8 - 20Rt-9
(a) Verify that initially real GDP equals 8,000 for both IS
curves.
Given that the interest rate has been 4 percent for the last
ten quarters, then for IS curve I, real
GDP equals 8,800 − 25(4) − 25(4) − 25(4) − 25(4) − 20(4) −
20(4) − 20(4) − 15(4) − 15(4) −
10(4) = 8,000. For IS curve II, real GDP equals 8,400 − 5(4)
− 5(4) − 5(4) − 5(4) − 10(4) −
15(4) − 15(4) − 15(4) − 20(4) = 8,000.
(b) Suppose that the Fed lowers the interest rate to 3% and
keeps it there for the next 10 quarters. Calculate real GDP for
the next 10 quarters for each IS curve.
For IS curve I, real GDP in the first quarter equals 8,800 −
25(3) − 25(4) − 25(4) − 25(4) −
20(4) − 20(4) − 20(4) − 15(4) − 15(4) − 10(4) = 8,025.
Using the same IS curve, it is easy to
show that for quarters two through ten, real GDP equals
8,050, 8,075, 8,100, 8,120, 8,140,

12. 8,160, 8,175, 8,190, and 8,200, respectively. For IS curve
II, real GDP in the first quarter equals
8,400 − 5(3) − 5(4) − 5(4) − 5(4) − 5(4) − 10(4) − 15(4) −
15(4) − 15(4) − 20(4) = 8,005. Using
the same IS curve, it is easy to show that for quarters two
through ten, real GDP equals 8,010,
8,015, 8,020, 8,025, 8,035, 8,050, 8,065, 8,080, and 8,100,
respectively.
(c) For each IS curve, what is the total increase in real GDP?
Real GDP increases by 200 billion for IS curve I. The
increase in real GDP for IS curve II equals
100 billion.
(d) For each IS curve, how many quarters does it take for the
incease in real GDP to equal one-half of the total increase?
For IS curve I, it takes four quarters, or twelve months, for
real GDP to increase by 100 billion
or one-half of the total increase in real GDP. For IS curve
II, it takes seven quarters, or twentyone
months, for real GDP to increase by 50 billion or one-half
of the total increase in real GDP.
(e) Using Figure 14-2 above, explain which one of the IS curves
resembles the economy’s response to a change in the interest
rate prior to 1991 and which one resembles its response since
1991. Explain how your answer is related to the interest-rate
parameters in each IS equation.
IS curve I resembles the economy’s response prior to 1991. The
increase in output in response to

13. a decline in the interest rate is larger than for IS curve II
and one-half of the total increase in
output occurs much sooner with IS curve I as compared to
IS curve II. IS curve II resembles the
economy’s response to a change in the interest rate since
1991.
The reasons why IS curve I resembles the economy’s
response prior to 1991 is that its interest
rate parameters for the first six quarters are larger than
those of IS curve II, and it is only for that
last quarter that IS curve I has a smaller interest rate
parameter than that of IS curve II. These
parameters reflect the fact that since 1991, the monetary
policy effectiveness lag has been longer
and the interest-rate multiplier has been smaller.
(f) Given your answers to parts b-d, explain how the changes in
the monetary policy effectiveness lag and the interest-rate
multiplier affects how much and how long monetary
policymakers must change interest rates in response to any
given demand shock.
The answers to Parts b through d indicate that for IS curve
II, real GDP rises less than it does for
IS curve I during any of the first seven time periods, for any
given increase in the interest rate.
Therefore, the changes in the policy effectiveness lag and
the interest-rate multipliers mean that

14. monetary policymakers now have to change interest rates
more in response to a given demand
shock than they did previously.
CH17, Problem 2 – Suppose that the equation for the aggregate
demand is Y = $9,000 + Ms / P, where Ms is the nominal money
supply and P is the price level. Initially the nominal money
supply equals $3,000. In addition, suppose that the expectations
of firms and workers are rational in the sense when people make
the best forecasts they can with the available data.
(a) Calculate points on the aggregate demand curve when the
price level equals 0.8, 1/0, 1.2, 1.25, and 1.5, given the initial
value of the nominal money supply.
The equation for the aggregate demand curve is Y = 9,000
+ 3,000/P, given that the nominal
money supply is initially 3,000. If the price level equals
0.8, the point on the aggregate demand
curve is Y = 9,000 + 3,000/0.8 = 9,000 + 3,750 = 12,750.
The same calculation shows that the
following points are on the aggregate demand curve:
(12,000, 1.0), (11,500, 1.2), (11,400, 1.25),
and (11,000, 1.5).
(b) Suppose that natural real GDP equals $12,000 and that the
short-run supply curve is given in the table below, where the
price surprise equals P – Pe and Pe is the expected price level:
Price surprise
-0.2
0.0

15. 0.2
0.25
0.5
Real GDP
11,900
12,000
12,100
12,125
12,250
Given that the expected price level is initially 1.0, explain why
the economy is in long-run equilibrium when the price level
equals 1.0 and real GDP equals $12,000.
The long-run equilibrium values of real GDP and the price
level are where aggregate demand
and long-run aggregate supply are equal. Long-run
equilibrium also requires the price level to
equal the expected price level or equivalently that the price
surprise is zero. Since the long-run
aggregate supply curve is vertical at natural real GDP and
since natural real GDP equals 12,000,
the long-run equilibrium values of real GDP and the price
level are also 12,000 and 1.0, given

16. that the expected price level is initially 1.0.
(c) Suppose that the real exchange rate declines as it did in
2006-2007 and as a result, aggregate demand increases. Also
assume that the decline in the real exchange rate will persist
over time. As a result of this decline, the new equation for the
aggregate demand is Y = $9,600 + Ms / P. Given no change in
the nominal money supply, calculate the points on the new
aggregate demand curve when the price level equals 0.8, 1.0,
1.2, 1.25, and 1.5, given the initial value of the nominal money
supply. Using the table given in part b, explain what the new
equilibrium price level and level of real GDP are in the short
run, given the price surprise induced by the decline in the real
exchange rate?
The decrease in the real exchange results in an increase in
aggregate demand so that the new
equation for the aggregate demand curve is Y = 9,600 +
3,000/P, given the initial value of the
nominal money supply. Therefore, if the price level equals
0.8, the point on the new aggregate
demand curve is Y = 9,600 + 3,000/0.8 = 9,600 + 3,750 =
13,350. The same calculation shows
that the following points are on the new aggregate demand
curve: (12,600, 1.0), (12,100, 1.2),
(12,000, 1.25), and (11,600, 1.5).
The new level of aggregate demand and short-run aggregate
supply are equal at real GDP equal
to 12,100 and a price surprise equal to .2. Therefore, the
new equilibrium price level equals 1.2

17. in the short run.
(d) Monetary policymakers respond to the decline in the real
exchange rate in one of three ways: (i) they do nothing and
leave the nominal money supply as is; (ii) they change the
money supply so as to return the price level to its level as given
in part b; or (iii) they change the money supply so as to
maintain the price level as determined by your answer to part c.
For each of these cases, assume that this is how monetary
policymakers have behaved in the past and this is how firms and
workers expect them to behave in response to the decline in the
real exchange rate. Calculate what the long-run equilibrium
price level is and what the expected price level is under each
response by monetary policymakers. Calculate by how much
monetary policymakers must change the nominal money supply
for the expectations of firms and workers to be realized.
If monetary policymakers respond to the decline in the real
exchange rate by doing nothing and
leaving the nominal money supply at its current level of
3,000, then the long-run equilibrium
price level is 1.25, since that is where aggregate demand
and the long-run aggregate supply are
equal at the natural real GDP level of 12,000.
If monetary policymakers change the money supply so as to
return the price level to 1.0,
which is what it was equal to in Part b, then the nominal
money supply, Ms, must be such that
12,000 = 9,600 + Ms/1.0 or Ms = 12,000 − 9,600 = 2,400.
That is, monetary policymakers must
reduce the nominal money supply to 2,400 for the price

18. level and the expected price level to be
equal at P = 1.0.
If monetary policy changes the money supply so as to keep
the price level equal to 1.2, which is
what it was in Part c, then the nominal money supply, Ms,
must be such that 12,000 = 9,600 +
Ms/1.2 or Ms/1.2 = 12,000 − 9,600 = 2,400. Therefore, Ms
= 1.2(2,400) = 2,880. That is,
monetary policymakers must reduce the nominal money
supply to 2,880 for the price level
and the expected price level to be equal at P = 1.2.
CH17, Problem 3 – Suppose that instead of persisting as is
assumed in problem 2, the decline in the real exchange rate is
only temporary in that the real exchange rate is only temporary
in that after the initial change in the price level that you found
in part c of problem 2, aggregate demand returns to its original
level.
(a) Given that monetary policymakers, firms, and workers all
recognize that the decline in the real exchange rate is only
temporary and given the three policy responses described in part
d of problem 2, again calculate what the long-run equilibrium
price level is and what the expected price level is under
response by monetary policymakers. Again calculate by how
much monetary policymakers must change the nominal money
supply for the expectations of firms and workers to be realized.
If the decline in the real exchange rate is only temporary,
so that the aggregate demand curve
returns to its original level, then given no change in the
nominal money supply, the economy is

19. long-run equilibrium when the expected price level and the
actual price level at 1.0. On the other
hand, if monetary policymakers change the nominal money
supply so as to maintain a price level
equal to 1.2 when aggregate demand returns to its original
level, then they must change the nominal
money supply to Ms′so that 12,000 = 9,000 + Ms′/1.2 or
Ms′/1.2 =12,000 − 9,000 or Ms′ =1.20(3,000)
= 3,600. That is, monetary policymakers would have to
increase the nominal money supply to 3,600
to keep the price level and expected price level equal to
1.2.
(b) Compare your answers to part d of problem 2 with those of
part a of this problem and explain why they are different.
If monetary policymakers do nothing in the sense of not
changing the nominal money supply, then
expected and actual price level rise if the decline in the real
exchange rate persists. The reason both
price levels rise is that firms and workers know it takes a
higher price level to offset the increase in
aggregate demand caused by the decline in the real
exchange rate, given that they expect monetary
policymakers to take no steps to offset that increase in
aggregate demand. On the other hand, if firms
and workers know that the decline in the real exchange rate
is only temporary, then they understand
that the increase in aggregate demand is also only
temporary. So if they expect that monetary
policymakers are not going to take any steps to respond to

20. the temporary changes in the real exchange
rate and aggregate demand, then they also know that the
price level returns to 1.0, so that is the price
level they expect.
Note, however, that if the decline in the real exchange rate
is expected to persist, so that the increase
in aggregate demand is also expected to persist and firms
and workers also expect monetary
policymakers to take actions to reduce the price level to 1.0
in the face of that increase in aggregate
demand, then monetary policymakers must reduce the
nominal money supply enough to shift the
aggregate demand curve back to its original level.
Finally, if firms and workers expect that monetary policy
makers will maintain the price level at 1.2,
then when the decline in the real exchange rate is expected
to persist, monetary policymakers must
take action so as to reduce aggregate demand so that
aggregate demand and long-run aggregate supply
are equal to 12,000 at a price level of 1.2. That reduction in
aggregate demand would require a
decrease in the nominal money supply. On the other hand, if
the decline in the real exchange is only
temporary and so also is the increase in aggregate demand,
then monetary policymakers would have
to increase aggregate demand so as to keep aggregate
demand and long-run aggregate supply equal to
12,000 at a price level of 1.2. That would require an
increase in the nominal money supply.
(c) Explain what data or other factors that monetary
policymakers, firms, workers might analyze in attempting to

21. determine if the decline in the real exchange rate is temporary
or will persist. Finally, suppose that monetary policymakers are
better able than firms and workers to determine if a change in
the real exchange rate is temporary or will persist and that firms
and workers know this. Given your answer to part d of problem
2 and part a of this problem, explain how once monetary
policymakers have determined whether the change in the real
exchange rate is only temporary or will persist, they could
signal their findings to firms and workers.
Policymakers, workers, and firms would look to data from the
foreign exchange markets and
economic conditions in the rest of the world in an attempt
to determine if there were changes in any of
these areas that would cause the decline in the real
exchange rate to either persist or only be temporary
in nature.
If monetary policymakers have always responded to changes
in aggregate demand by not doing
anything, then there is nothing that they can do to signal to
workers and firms whether the change in
the real exchange rate is going to persist or is only
temporary. On the other hand, if monetary policy-
makers have responded to changes in aggregate demand so
as to either maintain the price level at its
pre- or post-surprise level, then what they do to the nominal
money supply signals to firms and
workers what they have discovered concerning the nature of
change in the real exchange rate. For
example, if workers and firms expect that monetary
policymakers act so as to maintain the price level
equal to 1.0, its pre-surprise level, then monetary

22. policymakers can signal to workers and firms that
the decline in the real exchange is only temporary by
maintaining the nominal money supply at its
pre-surprise level. On the other hand, if monetary policy
makers discover that the decline in the real
exchange rate is going to persist, then they can signal that
to workers and firms by reducing the
nominal money supply. Finally, you should be able to figure
out how monetary policymakers can
signal to firms and workers what they know about the
change in the real exchange rate via a change in
the nominal money supply if workers and firms expect
monetary policymakers to maintain the price
level at 1.2.