Question #2:
Suppose the economy is initially described by the following equations.
Y = C + I + G
C = 220 + 0.63Y
I = 1,000 - 2,000R
X = 525 - 0.1Y - 500R
M = 0.1583Y -1,000R
p = 1.2 [(Y-1 - 6,000)/6,000]
The money supply is equal to $900 billion, government spending is $1,200 billion, and output is at its potential level of $6,000 billion with a price level of 1. Then there is a money demand shock. The new money demand equation is given by:
M = 0.1583Y -1,000R
In the year of the shock, compute the value of GDP, the price level, interest rates, and the
real money supply.
Using aggregate demand curves, illustrate the economy's path in the year of the shock
and in subsequent years.
Calculate the new long run equilibrium values for income, prices, interest rates, and the
real money supply.
Question #4:
Suppose the economy has the aggregate demand schedule
Y = 3,104 + 2.888
And a price adjustment schedule
p = p-1 + 1.2[(Y-1 - Y*)/Y*] + Z
Where Z is an exogenous price shock; potential GDP is Y* = 6,000.
Graph the aggregate demand schedule for M = 900. Graph the price adjustment schedule. Find the price level for Z = 0.
Suppose the economy starts with a price level of 1.0 and zero expected inflation. A price shock of 5 percent occurs in the first year (Z = 0.05). No further price shocks occur (Z = 0 in all future years). Trace the path of the economy back to potential by computing the values of the price level, GDP, unemployment, and expected inflation in each year for five years.
Repeat the calculations for the following monetary accommodation: The money supply is 5 percent higher starting in the second year. Compare this new path for inflation and unemployment with the original path.
Suppose, instead, that monetary policy tries to limit inflation by contracting the money stock by 5 percent starting in the second year. Repeat the calculations and compare with the original path.
Now suppose that there is no price shock (Z = 0 in all years) but the economy starts with expected inflations of 3 percent. Compute the path to potential. How much excess unemployment (over the natural rate of 6 percent) occurs in the process of returning to potential? Use Okun's law.