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[answered] 1) Consider an economy that is at general equilibrium (mean


Hi. It is a problem set of macroeconomics.
1) Consider an economy that is at general equilibrium (meaning labor, goods, and asset markets are all in

 

equilibrium). Suppose expected future marginal product of capital decreases.

 

a. Show how are IS curve, LM curve, and FE line are affected in the short run. Using IS-LM graph, explain

 

what happens to output, real interest rate, real wage rate, employment, real money supply, nominal

 

money supply, the price level in this economy in the short run.

 

b. Explain how the economy reaches general equilibrium. What happens to output, real interest rate, real

 

wage rate, employment, real money supply, nominal money supply, the price level in the new general

 

equilibrium?

 

c. Suppose you are a classical macroeconomist. Would you expect this demand shock to cause a

 

recession? Why or why not? What would be your policy recommendation to the government in response

 

to the shock?

 

d. Suppose you are a Keynesian macroeconomist. Would you expect this demand shock to cause a

 

recession? Why or why not? What would be your policy recommendation to the government in response

 

to the shock? 2) Suppose increased volatility in the prices of stocks and bonds raises real money demand.

 

a. Determine the effects of this change on output, the real interest rate and the price level using the ISLM model. Distinguish between the short-run and the long-run assuming price stickiness in the short run.

 

b. Determine the effects of this change on output, the real interest rate and the price level using the ADAS model. Distinguish between the short-run and the long-run assuming price stickiness in the short run.

 

c. Suppose that the government wants to stabilize output, i.e. keep the level of output constant, in the

 

short run. How can it use monetary and fiscal policies for this purpose? Explain and show the effects of

 

these policies on the IS-LM diagram.

 

d. Now suppose that the government aims to stabilize the real interest rate, i.e. keep the real interest

 

rate constant, in the short run.

 

e. Can it achieve this goal using monetary policy? Explain and show on the IS-LM graph. Can this new

 

equilibrium be a long-run equilibrium? Why? If not, explain the adjustment to long-run equilibrium and

 

compare it with the case in part (a).

 

f. What policy options does the government have to stabilize the real interest rate? Explain

 


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