Question

5) The economy has an aggregate production function fN=15N-12N2 , where N is labor input. Labor supply is given by NsWP=-5+3WP , where W is the money wage and P is the price level. Desired consumption depends on real income, Y, and can be written as CdY=10+0.7Y . Given real interest rate, r, the desired investment is Idr=30-200r . The real money demand is characterized by LY,r=10+Y-200r . Government spending, G, and nominal money stock, M, is given as G=0 and M=200 .

   (a) For any given level of output, find an equation that gives the real interest rate that clears the goods market.

   (b) For any given level of output, find an equation that gives the real interest rate that clears the asset market.

   (c) Find an equation for the aggregate demand curve.

   (d) What are the equilibrium values of output, consumption, investment, the real interest rate, and the price level?

   (e) Suppose that money supply doubles to 400. Discuss how the equilibrium values of output, consumption, investment, the real interest rate, and the price level will change. Is money neutral in this model?

   (f) Describe the changes in equilibrium values in part (e) using the IS-LM-FE diagram.

   (g) Describe the changes in equilibrium values in part (e) using the AS-AS diagram.

Answer 1

Part (A)

Part (B)

Part (C)

The aggregate demand curve shows the inverse relation between the aggregate price level and the level of national income.  Aggregate demand curve is a locus of points showing alternative combinations of P and Y that are consistent with the general equilibrium of the goods market and money market,

PArt (D)

aggregate supply is locus of points where labor market is in equilibrium that is labor demand equals labor supply