Question

Consider the closed-economy model.

(a) Use IS-LM and AD-AS diagrams to show what happens to the economy in the short-run, long-run, and during the transition, following an adverse supply shock . Explain in words what is happening.

(b) Suppose the central bank wishes to achieve output stability; that is, suppose the central bank would like to keep Y from ever changing. In response to the change in P from the adverse supply shock, what, if anything, can the central bank do to achieve this goal? How would the long-run equilibrium levels of Y , P and r in this case compare to the one where the central bank does nothing?

Answer #1

Consider the closed-economy model.
(a) Suppose the economy is initially in long-run equilibrium
with Y = Y¯ , r = ¯r, and P = P1. Draw IS-LM and AD-AS diagrams
showing this equilibrium.
(b) Suppose the economy is then hit by an adverse supply shock,
which causes P1 to jump up to P2 > P1. Using Keynesian cross and
money market diagrams, explain what will happen to the IS and LM
curves in the short run as a result of...

Consider the closed-economy model.Suppose the economy is then
hit by an adverse supply shock, which causes P1 to jump up to P2
> P1. Using Keynesian cross and money market diagrams, explain
what will happen to the IS and LM curves in the short run as a
result of this shock. Use IS-LM and AD-AS diagrams to
show what happens to the economy in the short-run, long-run, and
during the transition, following the supply shock.

Consider an economy that abides by a Dynamic AS/AD model as
presented in class, which, in period t-1, is in a short equilibrium
that happens to coincide with a long run equilibrium. In period t
there is a adverse supply shock. The shock remains for 2 periods
(t, t+1), but then dissipates fully in period t+2. Describe how
this economy reacts to this shock from periods t-1 through t+2.
Also discuss how the economy might transition to a LR equilibrium....

Assume the economy is initially in long-run equilibrium.
Explain briefly how short-run stagflation (recession combined
high inflation) results from an adverse supply shock. (Hint: Use
AD-AS diagrams to show what happens to P and Y.)
Suppose that stagflation occurs. To help economy go back to its
full-employment output, how should the government use her budgetary
tool that is based on corporate tax? Briefly explain your
answer.

Consider a closed economy, make sure to include an
explanation. Using an IS-LM-FE framework analyze the consequences
of the following event according to a Real Business Cycle
economist. Total factor productivity temporarily declines (adverse
supply shock).

Consider the following Keynesian (short-run) model along with
the Classical (long-run) model of the economy.
Labor Supply: Le = 11
Capital Supply: K=11
Production Function:
Y-10K.3(Le).7
Depreciation Rate: &=.1
Consumption Function: C=12+.6Yd
Investment Function: I= 25-50r
Government Spending: G=20
Tax Collections: T=20
Money Demand Function: Ld=
2Y-200r
Money Supply: M=360
Price Level: P=2
Find an expression for the IS curve and plot it.
Find an expression for the LM curve and plot it.
Find the short run equilibrium level of...

3. Use the classical model of a closed economy and the quantity
theory of money to predict how each of the following shocks would
affect real aggregate income (Y), the real interest rate (r), and
the price of goods and services (P) in a closed economy in the long
run, all else equal. For each shock, be sure to clearly state a
prediction for all three variables (up, down, or no change) and
illustrate your predictions with supply/demand diagrams for...

Suppose that in a closed economy the fiscal policy is
contractionary and monetary policy is expansionary, and the central
bank is setting the interest rates (LM is horizontal). Graphically
analyze this policy mix by using IS-LM diagram. What will be the
impact on real income and on interest rate in the short run? What
will be the impact of this policy mix on the economy in the medium
run? Show by using an AD-AS-LRAS diagram.

a. Consider a positive AD shock (i.e. increase in the AD curve)
hitting the economy. First, give examples of such a shock. Second,
use the AS/AD diagram to show both the short-run and long- run
effects of the shock. Third, explain step by step the adjustment
after the shock, i.e. both the short run deviation from LRAS and
the self-correction back to LRAS assuming policymakers do NOT
respond to the shock.
b. Now re-consider part a., assuming that the policymakers...

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...

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