Macroeconomics (9th Edition)
9th Edition
ISBN: 9780134167398
Author: Andrew B. Abel, Ben Bernanke, Dean Croushore
Publisher: PEARSON
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Chapter 10, Problem 5AP
To determine
To Evaluate: Effects on different economic variable under different condition using IS-LM model
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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.
In the Neoclassical-Keynesian Synthesis ASAD model, let us suppose that the interest rate has no effect on real money demand. What does this imply for (1) the slope of the IS curve, for (2) the slope of LM curve, and for (3) the slope of the AD curve?
(1) The slope of the IS curve –
(2) The slope of the LM curve –
(3) The slope of the AD curve –
Use the IS-LM model to answer this question. Suppose there is a simultaneous increase in government spending and reduction in the money supply. Explain what effect this particular policy mix will have on output and the interest rate. Based on your analysis, do we know with certainty what effect this policy mix will have on investment? Explain.
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Macroeconomics (9th Edition)
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- Use the IS-LM model to answer this question. Suppose there is a simultaneous increase in taxes and reduction in the money supply. Explain what effect this particular policy mix will have on output and the interest rate. Based on your analysis, do we know with certainty what effect this policy mix will have on investment? Explain.arrow_forwardD7) 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 the New Keynesian model, suppose that in the short run the central bank cannot observe aggregate output or the shocks that hit the economy. However, the central bank would like to come as close as possible to economic efficiency. That is, ideally the central bank would like the output gap to be zero. Suppose initially that the economy is in equilibrium with a zero-output gap. (a) Suppose that there is a shift in money demand. That is, the quantity of money demanded increases for each interest rate and level of real income. How well does the central bank perform in relative to its goal? Explain using diagrams. (b) Suppose that firms expect total factor productivity to increase in the future. Repeat part (a). (c) Suppose that total factor productivity increases in the current period. Repeat part (a). (d) Explain any differences in your results in parts (a)–(c) and explain what this implies about the wisdom of following an interest rate rule for the central bank. Problem 6 assumes that…arrow_forward
- Using 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_forwardConsider the following numerical example of the IS-LM model: C = 200 + 0.25YD I = 150 + 0.25Y - 1000i G = 250 T = 200 i = .05 (i has a bar over it) a. Derive the IS relation. (Hint: You want an equation with Y on the left side and everything else on the right.) b. The central bank sets an interest rate of 5%. How is that decision represented in the equations? c. What is the level of real money supply when the interest rate is 5%? Use the expression:(M>P) = 2Y - 8000i d. Solve for the equilibrium values of C and I, and verify the value you obtained for Y by adding C, I, and G. e. Now suppose that the central bank cuts the interest rate to 3%. How does this change the LM curve? Solve for Y, I, and C, and describe in words the effects of an expansion-ary monetary policy. What is the new equilibrium value of M/P supply? f. Return to the initial situation in which the interest rate set by the central bank is 5%. Now suppose that government spending increases to G = 400. Summarize the…arrow_forwardUse the IS-LM model to answer this question and assume that the central bank controls the interest rate. Suppose there is a simultaneous decrease in taxes and increase in interest rate. a. Explain what effect this particular policy mix will have on output and the money supply. b. Based on your analysis, do we know with certainty what effect this policy mix will have on investment? Explain.arrow_forward
- Supposed the economy is faced with persistently rising prices and there is a real threat of a worsening inflation. What specific actions/policy can the Central Bank implement to curb this threat and why? Based on the IS-LM model, if the Central Bank does this, which curve will shift and in what direction? Predict the effects of the Central Bank action on the following: Income: ________________ Interest Rate: ____________ Consumption: ___________ Investment: ______________arrow_forwardConsider the following numerical example of the IS-LM model: C = 200 + 0.25YD I = 150 + 0.25Y - 1000iG = 250 T = 200 i = .05 a. Derive the IS relation. (Hint: You want an equation with Y on the left side and everything else on the right.) b. The central bank sets an interest rate of 5%. How is that decision represented in the equations? c. What is the level of real money supply when the interest rate is 5%? Use the expression:(M>P) = 2Y - 8000i d. Solve for the equilibrium values of C and I, and verify the value you obtained for Y by adding C, I, and G. e. Now suppose that the central bank cuts the interest rate to 3%. How does this change the LM curve? Solve for Y, I, and C, and describe in words the effects of an expansion-ary monetary policy. What is the new equilibrium value of M/P supply? f. Return to the initial situation in which the interest rate set by the central bank is 5%. Now suppose that government spending increases to G = 400. Summarize the effects of an expansionary…arrow_forwardAccording to the IS-LM model, what happens in the short run to the interest rate, income, consumption, and investment under the following circumstances? Be sure your answer includes an appropriate graph (hand-drawn). Also, make sure to include a very short qualitative analysis of the policies, showing the chain effects of the variables discussed. Do not overwrite!a. The central bank decreases the money supply - Short-run and Long-run effects (transition from SR to LR) of this policy (Use AD-AS plus IS-LM model for this part)b. A housing market crash that reduces consumer wealth - Short-run and Long-run effects (transition from SR to LR) of this shock (Use AD-AS plus IS-LM model for this part)c. The government increases taxes - Short-run and Long-run effects (transition from SR to LR) of this policy (Use AD-AS plus IS-LM model for this part)d. After the invention of a new high-speed computer chip, many firms decide to upgrade their computer systems - Short-run and Long-run effects…arrow_forward
- Economics Suppose that the effects of COVID-19 on the economy can be thought of as a permanent negative productivity shock, i.e., a permanent decrease of the production owing to lower total factor productivity. What does the model predict will happen to the following variables: (1) real interest rate, (2) real output), (3) real consumption, (4) real investment, (5) labor input? For each variable explain why COVID-19 would have the predicted effect.arrow_forward(b) Use the IS-LM model to illustrate graphically the final impact of the reduction in government spending on output and interest rates under two possible scenarios: i) The Central Bank holds the money supply constant. ii) The Central Bank holds the level of output constant.arrow_forwardI have to analyze, using the IS-LM model, the macroeconomiceffects of an increase in savings in the short term and its implications for long-term growth. Specifically, I have to suppose that households (consumers) lose confidence and start saving more for any level of disposable income. The question is: Using the IS-LM model, show the effect of an increase in saving on production,investment and consumption, assuming that the Central Bank modifies the money supply when income changes, so that the LM curve is flat.arrow_forward
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