Describe how, if at all, each of the following developments affects the AD and/or IA curves:
a. Individuals become more optimistic about their future incomes, and therefore consume more out of a given amount of disposable income than before.
b. Exchange rates are floating, and American goods become more fashionable – that is, foreign demand for American goods at a given real exchange rate increases.
c. Anti-trust laws are relaxed, so firms charge higher prices for a given level of costs.
d. The demand for money increases (that is, consumers’ preferences change so that at a given level of i and Y they want to hold more real balances than before).
e. Investment demand becomes less sensitive to changes in the interest rate.
f. Oil prices increase, and at the same time consumption for a given level of disposable income falls.
Suppose that there is a technological disaster that makes workers less productive than before. Assume that initially output is at its natural rate.
a. How, if at all, does this affect the IA curve?
b. How, if at all, does this affect?
c. In light of your answers to (a) and (b), what is the immediate effect of the disaster on output and the real interest rate?
d. Can you tell how the long-run effect of the disaster on output compares with the short-run effect? Explain.
Suppose that initially output equals its natural rate, and that inflation is therefore steady. Now suppose that there is a sudden loss of investor confidence in a country, so that there is a large increase in the net capital outflow at a given real interest rate. Further, suppose that, in addition to our usual assumptions, the real exchange rate matters for aggregate supply. Specifically, suppose that a rise in the real exchange rate (because it lowers the costs of firms that import some of their inputs) is a favorable inflation shock, and that a fall is an unfavorable shock. Finally, assume that exchange rates are floating.
a. How, if at all, does the loss of confidence affect the AD curve?
b. How, if at all, does the loss of confidence affect the IA line?