Econ102SQ5Spring2007

# Econ102SQ5Spring2007 - UCLA Economics 102 E McDevitt SQ#5...

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UCLA Economics 102 E. McDevitt SQ#5: Classical model, Keynesian model, IS-LM Study Questions on the Classical Model 1. Use graphs of the labor market, production function, goods market, and money market to analyze the effects of the following on the real wage rate, employment, real output, the real rate of interest, national saving, desired investment, and the price level. a. An adverse temporary supply shock. b. A decrease in the money supply. c. A decrease in current T (lump-sum taxes). Assume that Ricardian equivalence holds. 2. Explain why the procyclical and leading characteristics of the money supply offer (or appear to) problems for classical-RBC model. What is reverse causation and how does it enable RBC theorists to explain the money supply business cycle facts? Study Questions on the Keynesian Model, IS-LM 1. Keynesian theory argues that a change in demand need not lead to a price change (at least in the short run). This claim appears to be contrary to microeconomic theory. What is the Keynesian justification for this claim? 2. a. Derive the IS curve using the goods market graph. b. What does the IS curve indicate? c. What do points lying above (below) the IS curve signify? d. Explain how each of the following shift the IS curve: i. A temporary increase in G. i. An increase in I d due to a permanent technological improvement. iii. A cut in T, holding G constant. (Assume that Ricardian equivalence holds.) iv. An increase in expected future income. v. A decrease in MPK f and a decrease in expected future income. 3. Derive the LM curve using the money market graph (with the real rate of interest on the vertical axis). What does the LM curve represent? What do points lying above (below) the LM curve signify? 4. Explain how each of the following cause the LM curve to shift: a. An increase in the nominal money supply. b. A decrease in the expected inflation rate. c. A 10% increase in the nominal money supply and the price level. d. Some unknown factor causes money demand to increase. 5. Use the IS-LM model (along with a brief written explanation) to determine the impact on the real rate of interest, real output, employment, and the price level. a. A decrease in the nominal money supply. Give both the classical and (short-run) Keynesian versions. b. A temporary negative supply shock. Give the classical version. c. A temporary decline in G. Give both the classical (without intertemporal labor substitution) and (short-run) Keynesian version. 6. Using graphs, explain how the elasticity of the investment curve affects the elasticity of the IS curve. How does the elasticity of the IS curve impact the effectiveness of monetary policy in the Keynesian model? Use graph to explain. What is the intuition of this result? How does the elasticity of the IS curve impact the effectiveness of fiscal policy in the Keynesian model? Use graph.

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