Assignment
QUESTION NUMBER ONE
Long Run Aggregate Supply and the Production Function
Now you want to "improve" the aggregate production function to increase the supply capacity of the economy. That is, you desire to move the vertical LRAS to the right on the AS/AD diagram.
(1) List four initiatives that you would focus upon to get the job done.
II
Let's say your economy is at a less-than-full-employment equilibrium WITH AN UPWARD SLOPING SHORT RUN AGGREGATE SUPPLY CURVE (SRAS). Your LRASsuddenly moves to the right. You want to get back to full employment as quickly as possible. (CLOSED ECONOMY)
(2) Defend your use of either monetary policy or fiscal policy to do this. That is, choose monetary or fiscal policy and defend its advantages over its disadvantages. (8 points possible)
(3) If monetary policy is chosen, what might happen to PRICE EXPECTATIONS and how may these expectations affect the outcome of your policy initiative? If fiscal policy is chosen, what might happen to price expectations and how economy will be affected? (9 points possible)
QUESTION NUMBER TWO
The Keynesian Cross and the IS (savings - investment) curve-Closed Economy)
Note: In your answer, draw as many diagrams as you think will adequately demonstrate your knowledge of the issue. Do not clutter your diagrams needlessly, but carefully label your diagrams and describe your solutions in words.
Your economy has a marginal propensity to consume (MPC) of 0.70. It is currently operating at a level at less than full employment. Prices appear to be sticky in this economy, but by some lucky stroke the rate of interest falls. This interest rate change causes private investment (1) to rise by 40 billion dollars.
(1) Using the Keynesian Cross diagram indicate by how much national income (Y) will rise once the economy completely absorbs the 40 billion in new investment? Describe the logic by which you get to your answer (7 points possible)
(2) What will happen to the level of national savings (S) once the economy has fully reacted to the new 40 billion in investment? Describe the logic by which you get to your answer. (8 points possible)
(3) What does the dynamic that you just described in (1) and (2) above tell you about the shape of the IS curve? How is the IS curve (its slope and position in the graph) related to the economy's Investment Demand Function? (8 points possible)
(4) In the IS- LM diagram, there is no fall in the interest rate, but there is a new $40 billion spending by your government. Does this government spending have the same impact on national income as the $40 billion new "I" did in your answer to part (1) above? If yes, why? If not, why not? (10 points possible)
QUESTION NUMBER THREE
IS - LM and the link to AD - AS (SRAS HORIZONTAL - CLOSED ECONOMY)
Note: In your answer, draw as many diagrams as you think will adequately demonstrate your knowledge of the issue. Do not clutter your diagrams needlessly, but carefully label your diagrams and describe your solutions in words.
YOUR ECONOMY IS IN A LESS-THAN-FULL-EMPLOYENT EQUILIBRIUM. Suddenly there is a fall in the aggregate price level to a lower level, (perhaps the result of an agreement to lower the wages and benefits of all industrial workers in the economy, or as a result of a new technology "A", that lowers the cost structure for all businesses and that lower cost is passed on to the consumer in the form of lower prices as well).
(1) Show what occurs in the IS - LM diagram. What happens to the positions of the curves in the diagram immediately due to the fall in "P'"? What happens to the interest rate and to the level of income? Explain your answers. (5 points possible)
(2) Now turn to the AS/AD diagram. What happens to the curves (lines) on this diagram in the short run from the sudden fall in "P"? What happens to the level of "Y"? (5 points possible)
(3) Let's say that he initial fall in "P" resulted in a new equilibrium where "Y" that is still at less than full employment. In this case, what happens on the two diagrams IN THE LONG RUN (IS - LM) and (AS - AD) if no government policy action is taken? (5 points possible)
(4) Does the AD curve remain in a fixed position in your answer in (3) above? If yes, why? If no, why not? (5 points possible)
(5) Now, BEGIN AGAIN at your initial position at less than full employment and show in the two diagrams what would occur if the government legislates a spending increase. What happens to the AD curve in this ease? What happens to "r", "P", and "Y"? (5 points possible)
(6) Does the economy benefit from the full Keynesian multiplier impact of the new government spending, dY/dG = 1/ (1 - MPC)? Please explain your answer in terms of the dynamic in the IS-LM diagram. (8 points possible)