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Problem Set 4

# Problem Set 4 - PROBLEM SET 4(1 Consider a closed economy...

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PROBLEM SET 4 (1) Consider a closed economy with the following data: N K Y = K = 100 N K MPN 1 2 1 = Labor supply is inelastic so that: N = 10000 The money market clearing condition is given by 0 ) ( 200 2 . 0 1 = + = e e r Y P M π π High powered money: H = 4000 Currency/deposit ratio: cu = 0.5 Reserve/deposit ratio: res = 0.5 a) Derive the FE line in this economy and compute the real wage b) Suppose that the IS curve is given by r = 10 - 0.0005Y. Derive the LM curve as a function of Y and H/P . [Express it in the form r = f(Y,H/P) ] Hint: Use the formula H res cu cu M + + = 1 1 (2) Assume that the objective of the central bank is to keep output at Y = 10000 in the short run. The price level in the short run is 2 and prices are fixed in the short run. Full employment output is 10000 = Y . The IS curve is given by: r = 12 - 0.001Y However, there is disagreement about the location of the LM curve. As a result the central bank does not know where the LM curve is located, but it knows that there are two scenarios. Under scenario A, the LM curve is given by: i = 0.01Y - 0.002M/P

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