Question

THIS IS THE GENERAL EQUILIBRIUM PROBLEM THAT I PROMISED. YOU
FIRST SOLVE FOR THE INITIAL EQUILIBRIUM AS POINT A. WE CONSIDER TWO
DIFFERENT AND SEPARATE SHOCKS (I CALL THEM SCENARIOS). THE FIRST
SHOCK IS TO THE IS CURVE, THE SECOND SHOCK IS A ‘LM’ SHOCK. AGAIN,
WE CONSIDER THESE SHOCKS SEPARATELY SO THAT AFTER YOU COMPLETE
SCENARIO 1 (THE IS SHOCK), WE GO BACK TO THE ORIGINAL CONDITIONS
AND CONSIDER THE SECOND SCENARIO WHICH IS THE ‘LM’ SHOCK.

Consider the following model of the economy

Production function: Y = A·K·N – N^{2}/2

Marginal product of labor: MPN = A·K – N.

where the initial values of A = 6 and K = 10.

The initial labor supply curve is given as: N^{S} = 30 +
4w

Initial conditions in the goods market

C^{d} = 120 + .50(Y-T) – 500r

I^{d} = 800 – 500r

G = 100

T = 100

M^{d}/P = 218 + 0.5Y- 1000(r + π^{e})

Nominal Money supply M = 3000

Expected inflation is equal to 3% (π^{e} = 0.03)

1 a) (6 points) Solve for the labor market clearing real wage (w*),
the profit maximizing level of labor input (N*), and the full
employment level of output (Y*). Please show work.

Draw two diagrams vertically with the labor market on the bottom
graph and the production function on the top graph. Be sure to
label everything including this initial equilibrium point as point
A. (10 points for completely labeled and correct diagrams)

b) (4 points) Derive an expression for the IS curve (r in terms of
Y). Please show all work

c) (3 points) Find the real interest rate that clears the goods
market. Please show all work

d) (3 points) Find the price level needed to clear the money
market. Please show all work

e) (4 points) Find the expression for the LM curve (r in terms of
Y). Please show all work

Now draw four separate diagrams: (40 points total) Top left: a
desired savings equals desired investment (S^{d} =
I^{d} ), Top right: a FE - IS – LM diagram, Bottom left: a
money market diagram, Bottom right: An AD - AS diagram, locating
this initial equilibrium point as point A. BE SURE to LABEL all
diagrams completely (10 points for each correctly drawn and labeled
diagram…each diagram will have three different equilibriums points
A, B, and C)

SCENARIO #1 – AN IS SHOCK!

Suppose that the consumption function has changed and is now

C^{d} = 140 + .50(Y-T) – 500r

S1 a) (4 points) Name and support two reasons why the consumption
function would change like this.

S1 b) (6 points) What is the new, short run (fixed price level)
expression for the IS curve? Please show all work.

S1 c) (4 points) What is the short run, Keynesian (fixed price)
level of equilibrium output and real interest rate? Please show all
work.

Please label these new short run conditions to your four diagrams
as point B. Be sure to label diagrams completely with the inclusion
of all the relevant shift variables like we did numerous times in
the video lectures.

S1 d) (4 points) Find the real interest rate associated with the
long run general equilibrium.

S1 e) (4 points) Find the new price level associated with the long
run general equilibrium.

Please label these long run conditions to your four diagrams as
point C. Be sure to label diagrams completely with the inclusion of
all the relevant shift variables like we did numerous times in the
video lectures.

S1 f) (5 points) Now we know that one of the Fed's mandates is
price stability. What would the Fed have to do, in terms of open
market operations, so that the price level remains at its initial
value? Assume the money multiplier is 0.8. Please show your
work.

SCENARIO #2 – AN LM SHOCK!

Let’s return to our original conditions: Please write down the
expressions for your ORIGINAL IS curve and LM curves (so the grader
can follow your starting points).

IS: r = ___________________________

LM: r = __________________________

Now draw four separate diagrams: (40 points total) Top left: a
desired savings equals desired investment (S^{d} =
I^{d} ), Top right: a FE - IS – LM diagram, Bottom left: a
money market diagram, Bottom right: An AD - AS diagram, locating
this initial equilibrium point as point A. BE SURE to LABEL all
diagrams completely (10 points for each correctly drawn and labeled
diagram…each diagram will have three different equilibriums points
A, B, and C)

SCENARIO #2– AN LM SHOCK!

S2 a) (4 points) Now suppose that there is a shock to real money
demand so that the new real money demand function is:

M^{d}/P = 248 + 0.5Y- 1000(r + π^{e})

Name and support two reasons why the nominal money stock might
change like this - please do your best to relate your answer to
real world events.

S2 b) (6 points) What is the new, short run (fixed price level)
expression for the LM curve? Please show all work.

S2 c) (4 points) What is the short run, Keynesian (fixed price)
level of equilibrium output and real interest rate? Please show all
work.

Please label these new short run conditions to your four diagrams
as point B. Be sure to label diagrams completely with the inclusion
of all the relevant shift variables like we did numerous times in
the video lectures.

S2 d) (4 points) Find the new price level associated with the long
run general equilibrium.

Please label these long run conditions to your four diagrams as
point C. Be sure to label diagrams completely with the inclusion of
all the relevant shift variables like we did numerous times in the
video lectures.

S2 e) (4 points) Let us focus on the movement from point A to B
(the short -run) in your money market diagram. Explain why (and in
what direction) the real interest rate had to change to 'clear' the
money market. Be as specific as possible as we talked about this a
great deal in the video lectures!

S2 f) (5 points) Now we know that one of the Fed's mandates is
price stability. What would the Fed have to do, in terms of open
market operations, so that the price level remains at its initial
value? Assume the money multiplier is 0.8. Please show your
work.

S2 g) (5 points) What else could the Fed do, besides conducting
open market operations, in order to for the price level to remain
at its initial value?

Answer #1

Assume the economy is in an initial general equilibrium (1).
Then there is an increase in government spending. Show the movement
to a new temporary equilibrium (2). Then after the economy adjusts,
we move to a final general equilibrium (3). You must show all three
points ( 1,2,3) in all five diagrams —Y=f(N), Nd/Ns, I/S, Ld/Ms/P
and IS/LM--- making sure they line up and tell a consistent story.
Label all axes.

2. Aggregate demand
a. Write down the AD relation.
b. Use the IS-LM model to derive the AD curve. What could cause
the shift of AD curve?
3. Monetary expansion
a. Assume the economy is initially at Yn. Draw the AD-AS model
and label the initial equilibrium as A. Draw the corresponding
IS-LM model and indicate the equilibrium A.
b. Suppose now there is a monetary expansion. Show the short run
effect on price level, output, and interest rate in...

We discussed numerous times the importance of identifying shocks
to money demand. In particular, we argued that the policy
implications of shocks to money demand differ based on whether the
shock to money demand was real or portfolio.
a) (5 points) Let us consider a portfolio shock that increases
money demand, say due to non-monetary assets becoming riskier and
less liquid. Draw a real money demand and real money supply diagram
locating the initial equilibrium point as point A and...

I only need part B, part A is for
reference.
A) Assume the economy is at full employment. Use the IS-LM/
AD-AS model to show the short-run and long-run impacts of a
positive demand shock such as an increase in business confidence
and investment spending on: the real interest rate (r), real GDP
(Y), unemployment (U), consumption spending (C), the nominal money
supply (M), the price level (P) and the real value of the money
supply(M/P). You must present properly...

Use the foreign exchange and money market diagrams to
answer the following questions about the relationship between the
Indian rupee (INR) and the Euro (EUR). Let the exchange rate be
defined as rupees per yuan EINR/Eur. Suppose there is a fall in the
Indian nominal money supply. Make the usual assumptions: UIP holds,
PPP holds in the long run, prices are sticky in the short run,
(20p)
-- Now assume instead that the fall in money supply is
permanent. Illustrate...

1. Use the money market and foreign exchange (FX) diagrams to
answer the following questions. This question considers the
relationship between the euro (e) and the U.S. dollar ($). Let the
U.S. be “Home” and the European Monetary Union (EMU) be “Foreign”.
Let the exchange rate be defined as U.S. dollars per euro, E$/e.
Assume, for simplicity, that European money supply, M∗ , liquidity
preferences L ∗ , price level P ∗ , nominal and real interest
rates, i ∗...

Use the money market and FX diagrams to answer the following
questions about the relationship between the British pound (£) and
the U.S. dollar ($). The exchange rate is in U.S. dollars per
British pound E$/£. We want to consider how a change in the U.S.
money supply affects interest rates and exchange rates. On all
graphs, label the initial equilibrium point A.
a. Illustrate how a temporary increase in the U.S. money supply
affects the money and FX markets....

QUESTION 19
In an economy with MPC = 0.8, and according to the goods market
equilibrium equation in the IS-LM model, to increase (equilibrium)
total output, Y, by 8, the government can:
A.
cut/lower the level of taxation, T, by 1.
B.
cut/lower the level of taxation, T, by 2.
C.
increase the level of taxation, T, by 2.
D.
none of the above.
10 points
QUESTION 20
Every point on an IS curve represents:
A.
a combination of...

Assume that the consumption function is given by
Ct = 150 + 0.75(Yt –
T)
I = 250; G = 500; T = 500
(2 point) Write down the planned expenditure as a function of
current output/income (Yt):
PE (Yt+1) =
____________________________________.
(4 points) What is the equilibrium level of income? Show your
work.
(4 points) If G increases to 550, what is the new equilibrium
level of income? Show your work.
Given
Yt+1=Ct+I+G
Ct=50+0.8(Yt-T)
I = 200 – 5r...

Consider the following economy (with flexible exchange rate
system):
• Desired consumption: Cd = 300 + 0.5Y − 2000r
• Desired investment: Id = 200 − 3000r
• Government purchases: G = 100
• Net export: NX = 350 − 0.1Y − 0.5e
• Real exchange rate: e = 20 + 1000r
• Full employment: Y ̄ = 900.
• Nominal money stock: M = 4354
• Real money demand: L = 0.5Y − 200r
(a) Find the equations for...

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