Macroeconomics
10th Edition
ISBN: 9780134896441
Author: ABEL, Andrew B., BERNANKE, Ben, CROUSHORE, Dean Darrell
Publisher: PEARSON
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Question
Chapter 10, Problem 1AP
a)
To determine
The effect of increase in the expected future MPK, using the IS-LM model on the following:
- Current output
- The real interest rate
- Consumption
- investment
- the
price level
b)
To determine
The effect of increase in the expected future MPK, using the AD-AS model on the following:
- Current output
- The real interest rate
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In this question, we assume Canada is a closed economy and is in its long-run equilibrium. TransCanada announced that they will not proceed with the East Energy pipeline in October 2017.
a) According to the long-run classical model, what happens to the equilibrium levels of output, real interest rate, and investment in Canada after TransCanada made this announcement? What happens to the real wage in Canada? Explain your answer with the aid of TWOdiagrams - one for the loanable funds market and one for the labour market.
b) (Continued from part a) As time passes (i.e., in the very long run which will be 10-15 years from now), what happens to the stocks of productive inputs in Canada? How would this change in the stocks of productive inputs affect the equilibrium levels of output and real interest rate in Canada? What happens to the real wage in Canada? Explain, and support your answer by a new set of loanable funds market and one for the labour market diagrams
Suppose the economy is initially in its long-run equilibrium. Due to the biased (overestimated) expectation of return, the entrepreneurs overwhelmingly become much more aggressive in investment holding other things equal.
a. Use the IS-LM model and AD-AS model to graphically illustrate the impact of the biased expectation in the short run and in the long run. What are the changes in the equilibrium real interest rate, output, and prices?
b. If the central bank wants to offset the impact of the biased expectation, what is the appropriate measure? Draw a graph as in part a. for illustration. What are the changes in the equilibrium real interest rate, output, and prices in this case?
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.
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- D7) IS-LM Model: Based on your understanding of the IS-LM model, graphically illustrate and explain what effect a monetary expansion will have on output, the interest rate, and investment. ( Properly)arrow_forwardIn this question, we assume Canada is a closed economy and is in its long-run equilibrium. TransCanada announced that they will not proceed with the East Energy pipeline in October 2017. According to the long-run classical model, what happens to the equilibrium levels of output, real interest rate, and investment in Canada after TransCanada made this announcement? What happens to the real wage in Canada? Explain your answer with the aid of TWOdiagrams - one for the loanable funds market and one for the labour market.arrow_forwarda) Which of the following would a classical macroeconomist disagree with? The interest rate is the price of time or productivity of capital Nominals effect nominals Recessions are caused by an over production of all economic goods Prices should be as flexible as possible Effective demand comes from prior supply b) Which of the following is true? The expected costs and returns for holding money are important for estimating the demand of real cash balances The difference between nominal GNP and real GNP is that nominal GNP has been adjusted by a price deflator to account for changes in the value of money (inflation) People in Group 1 receive the inflation tax on their cash-balances Interest is the price of money The real money supply is equal to the nominal money supply divided by the real money supplyarrow_forward
- In an economy, the money supply growth rate is 5.0%, the equilibrium real interest rate is 1.5%, the potential growth rate is 4.0%, the economic growth rate is 1.0%, the inflation rate is 3.0%, the unemployment rate is 4.5%, and the rate of increase in the circulation speed is -2%. In this case, in an economy that pursues an inflation target of 2.0%, what is the appropriate interest rate target based on Taylor's rule? (Omit the unit and answer with the first decimal place.)arrow_forwardSuppose the parameters of the IS curve are a_bar = 0, b_bar = 1/2, r_bar = 2%, and R = 3%. Calculate the initial short-run output. Calculate the short-run output when real interest rate rises to 5%. Calculate the short-run output when real interest rate goes to 0. What’s the value of real interest rate when the economy is outputting at its long-run level.arrow_forwardUsing the IS LM model, show how expansionary monetary and expansionary fiscal have same effect on output but opposite impact on interest rates. b. Derive the equations for IS and LM curves from the set of equations given below: C = 80+ 0.75Yd I = 300-200 i G is government expenditure G = 30 T = 30 where T= taxes Ms = 270 where Ms is money supply Md = 150+ 0.30Y – 300i Find the volume of investment at equilibrium . What would be the impact on investment if Money supply is increased to 300.arrow_forward
- The _____________ is inversely related to the real interest rate. Multiple Choice: LM curve quantity of real money demanded quantity of real savings quantity of real investment suppliedarrow_forwardThe following equations describe a Keynesian model of a closed economy: C = 500 - 0.5(Y - T) - 100r I = 350 - 100r L = 0.5Y - 200i πe = 0.05 G = T = 200 Y = 1850 M = 3560 a. Find the full-employment equilibrium values of the real interest rate, consumption, investment, and the price level. b. Suppose government purchases decline to 175, with no change in taxes. What happens to the real interest rate, output, consumption, and investment in the short run (in which the price level is fixed)? What happens in the long run to the real interest rate, consumption, investment, and the price level? c. Suppose instead that government purchases rise to 225, with no change in taxes, starting from the equilibrium in part (a). What happens to the real interest rate, output, consumption, and investment in the short run (in which the price level is fixed)? What happens in the long run to the real interest rate, consumption, investment, and…arrow_forwardWhat is the impact of monetary and fiscal policy if (a) money demand does not depend on income, LM curve is horizontal; and (b) If money demand is extremely sensitive to interest rate, LM curve is horizontal.arrow_forward
- Which of the following statement is false? A. Consumption smoothing occurs when people borrow and save to smooth consumption over their lifetime. B. When making decisions about savings and borrowing, households and firms care more about the nominal interest rate than the real interest rate. C. Fisher equation describes the relationship between nominal and real interest rates under the effect of inflation. D. Movement along the demand curve for loanable funds is caused by a change in the interest rate.arrow_forwardInstructions: Please read all questions carefully and make sure you understand the facts before you begin answering. Write legibly and be as concise as possible. 1. Using the ISLM model, show graphically, and explain the effects of a monetary expansion combined with a fiscal contraction. How do the equilibrium level of output and interest rate change? 2. Explain the difference between Keynesian economics and Classical economics by mentioning the complete name of the economist who develops the theory/model. 3. Describe each of the components of the GNP equation and which one you feel can distort GNP the most. 4. With the topics discussed within Macroeconomics, which topic do you feel is most influential on our nation’s economy? Describe the topic and then use 5 bullet points to defend your position? 5. Draw the graph of the Keynesian cross model as a comparison of planned and realized expenditures. What is the intercept of the planned expenditure line?…arrow_forwardConsider the following IS–LM model: C = 100 + .25YD I = 50 + .25Y - 1000i G = 150 T = 100 (M/P) d = 2Y - 8000i (M/P)s = 1000 a. Derive the IS relation b. Derive the LM relation c. Solve for equilibrium real output. d. Solve for the equilibrium interest rate e. Solve for the equilibrium values of C and I f. now suppose that the money supply increases to M/P = 1010. Solve for T, f. suppose that government spending increases to G = 155 What is the value of money supply? g. From what we studied, which policy, expansionary fiscal policy or expansionary monetary policy will undoubtedly increase investment.arrow_forward
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