1. If there is no shock and yet the economy in the SR has an excess supply (ES) of goods and an excess demand (ED) for money, what, if anything, will happen, and why? Show where the economy is and what will happen using the IS-LM graph. Make all your assumptions clear. Note: a reasonable assumption is that the interest rate changes more quickly than does Y and the interest rate responds to money market diseqm, whereas Y responds to goods market diseqm.
2. The Republicans have proposed instituting a "balanced-budget amendment" (BBA) as a way to avoid running GBDs (govt budget deficits) in the future and to ensure that the current GBD doesn't get any larger. This means that if G increases, e.g., then net taxes, T, must also increase so that the net effect on the GBD is 0. To keep things simple, let's examine how a BBA works by assuming that the economy starts at Yn (or YFE) with G=T so it has a balanced budget; assume T=net taxes=tY, where t is the income tax rate, and Transfer Payments are zero. Use IS-LM analysis in the SR to see what will happen if consumer confidence falls (ceteris paribus). No math is necessary; make all your assumptions clear.
3. Consider the following SR (i.e., IS-LM with P fixed) model (all amounts are in millions of dollars):
C = 50 + .6 YD
T = 20
G = 300
I = 450 + .2 Y - 1500 i
(M/P) = 1,200
(M/P)d = 3Y - 4000 i
a. Derive equations for IS and LM and then solve for equilibrium (eqm) real output, Y and eqm interest rate, i.
b. Graph the equilibrium in three, appropriately linked-up OR separate graphs: i-Y, i-(M/P), and Z-Y spaces.
c. Suppose Congress decides to increase G from 300 to 305. Calculate what the new eqm i and Y will be. Some analysts are worried that stimulus packages (specifically, the G increase) could "crowd out" (or reduce) I. What do you think? If I did fall, why would this be a concern? Make calculations to see whether or not I does indeed fall for this economy following the G increase.
d. Show in the three graphs of part b. above what this G policy will look like.
e. Present and discuss all changes in all components of IS and LM.
4. Are the following statements True, False, or Uncertain? You must show what happens in i-Y and P-Y space diagrams that are appropriately linked up. Assume in parts b and c that we start in equilibrium (at the end of the MR) at Yn and follow the directions. Assume each "shock" is ceteris paribus. Explain fully and make all your assumptions clear. Note: For a statement to be true, every part of it must be true.
a. To derive the Aggregate Demand (AD) curve graphically, the experiment is to change Y in i-Y space and see what happens to P.
b. The ongoing merger activity (as stronger firms take over weaker firms in the financial sector and elsewhere) means that overall, cet. par., in the US economy, firms will become less competitive (that is, there will be more monopolies), so un will fall and Yn will rise. This means that prices will fall throughout the MR, which will shift both the LM and AD curves out to the right.
c. If tastes change such that everyone in the U.S. decides to hold more money (M1) then (cet. par.) in the SR LM will shift in but over the MR it will shift back out as workers' weaker bargaining power leads to lower W, which shifts the AS curve out and lowers P. At the end of the MR, Y will remain below the initial Y, Yn.