a) Explain the concept of consumption smoothing and how it can overcome the ap- parent empirical failures of the standard Keynesian consumption function. b) Explain how the Real Business Cycle theory of economic fluctuations works de- scribing the main shocks and their propagation mechanisms. c) Explain how the problem of time-inconsistency in monetary policy can affect the trade-off between inflation and unemployment.

a) Explain the concept of consumption smoothing and how it can overcome the ap- parent empirical failures of the standard Keynesian consumption function. b) Explain how the Real Business Cycle theory of economic fluctuations works de- scribing the main shocks and their propagation mechanisms. c) Explain how the problem of time-inconsistency in monetary policy can affect the trade-off between inflation and unemployment.

ECON MACRO

5th Edition

ISBN:9781337000529

Author:William A. McEachern

Publisher:William A. McEachern

Chapter10: Aggregate Supply

Section: Chapter Questions

Problem 2.3P

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Consider the classical AS-AD model with misperceptions. Assume that the economy is initially at its general equilibrium. Now, suppose the central bank considers an increase in the nominal money supply that is not anticipated by households or firms. a. How does the misperception theory work? b. Which of the three markets is first affected (labor, goods, or asset market)? Explain and show graphically how this market is affected by an unanticipated increase in the nominal money supply. c. Use the classical version of the AS-AD model with misperceptions to explain and to show graphically how an unanticipated increase in the nominal money supply affects the short-run equilibrium. d. Use the classical version of the AS-AD model with misperceptions to explain and to show graphically how an unanticipated increase in the nominal money supply affects the long-run (general) equilibrium.
Consider the ASAD model of a closed economy with zero ongoing inflation and workers misperceptions. Firms are perfectly competitive, produce output with diminishing marginal returns to labour and have perfect foresight over the price level. Workers, instead, expect zero inflation in each period. At time zero, the economy is in the potential equilibrium. There is a negative shock on aggregate demand – for example, a permanent fall in desired autonomous consumption at time t = 1. What are the effects of the shock on the equilibrium real wage in the short and in the medium run?
Assume a Keynesian AS curve. In the short run, when there is a large negative output gap (AD-AS intersection far to the left of the full employment level of output), then 1.expansionary demand management policy is likely to be highly inflationary 2.expansionary demand management policy does not cause much inflation 3.the government should use contractionary demand management policy 4.contractionary demand management policy is likely to be highly inflationary
An economy is currently in a recession. (a) Draw a single correctly labeled graph with both the short-run and long-run Phillips curves. Label the current short-run equilibrium as point X. (b) Is the expected inflation rate greater than, less than, or equal to the actual inflation rate? (c) Will borrowers on fixed-rate loans benefit from the situation that you identified in part (b)? Explain. (d) Assume the government budget is balanced. In the absence of any discretionary policy action, will the government budget move into surplus, deficit, or remain in balance? Explain. (e) On your graph in part (a), show how the economy will adjust in the long run in the absence of any discretionary policy action. (f) Now assume instead the government increases spending without changing taxes to close the recessionary gap. What effect will this policy have on the national debt? (g) Draw a correctly labeled graph of the loanable funds market and show the effect of the change in the national debt…
In the extended version of the classical model, based on the misperceptions theory. a. Graphically show the effect of an unanticipated increase in money supply using the AS-AD model. Make sure to label the short-run equilibrium point. b. Repeat part (a). This time, assume that the public was anticipating this increase in money supply. c. Is the short-run equilibrium in part (b) point the same as in part (a). Why or why not?
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Consider an AD-AS model with AD curve Y – Y* = - αγ (π - π*) + εand AS curve π = π + φβ(Y – Y*) + εwith parameter values α = 0.5, γ = 1, φ = 1, β = 0.5,and with inflation target π* = 0.02 and potential output normalised to Y* = 1.Starting from a long-run equilibrium with π = π* suppose there is a temporary demand shock ε = -0.05. Which of the following is TRUE? 1.In the short run, output is 5% below trend 2.In the short run, output is 4% below trend 3.In the short run, inflation is 1% 4.In the long run, output is 5% below trend
Consider the ASAD model of a closed economy with zero ongoing inflation in the medium run. The aggregate demand curve is determined by the IS-LM model. The aggregate supply curve is derived from the imperfect competition model of the labour market (the WS-PS model where firms have perfect foresight, monopoly power, and use a linear technology with constant returns to labour; workers expect zero inflation in every period, and their wage requests are an increasing function of wage-push factors like unions' bargaining power). The economy is initially in the potential equilibrium. Assume a permanent increase in the bargaining power of unions. Fiscal and monetary authorities perfectly forecast this shock and decide to neutralize immediately its consequences for the price level by enacting a “policy of price stability” that successfully eliminates all fluctuations in the general price level in every period. Therefore, the economy is subject to two simultaneous shocks – the increase in…