homework5spring2005

homework5spring2005 - Economics 302 Prof. Kelly Problem Set...

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Economics 302 Prof. Kelly Problem Set 5 Due: Wednesday, April 27 Exercise 1 Comparing Classical and Keynesian-Sticky Price Models Consider the market for wheat. In Econ 101, you analyze this market by …nding the equilibrium price and quantity as the point where the supply curve intersects the demand curve. If we throw out the graph and handed our functions for supply and demand to a mathematician, she would see two equations (an equation that gave the quantity supplied as a function of price and an equation that gave the quantity demanded as a function of price) and two unknowns (price and quantity) [to be technical, there is a third equation in the system: that quantity demanded equals quantity supplied equals quantity]. This system of equations produces an equilibrium because we have the same number of equations as unknowns. Now, consider the whole economy. We have 3 unknowns: output, the real interest rate, and the price level. Since we have 3 unknowns, to solve for these 3 unknowns, we better have 3 equations to describe what is going on. a) Before reading the rest of the question, can you think which 3 equations we are going to use (Hint: what equations/relations connect r, Y, and P)? Try and explain why you are selecting these 3 equations. Don’t worry about getting this wrong or right, just think. The rest of this question proceeds through a series of steps, building the necessary equations one-by-one Step 1 Loanable Funds Market: The marginal propensity to consume is mpc. Full-employment output (the output of the economy when
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homework5spring2005 - Economics 302 Prof. Kelly Problem Set...

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