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ps6-1 - 4 a Suppose the economy begins at full employment...

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Economics 205: Principles of Macroeconomics Mark Moore Fall 2008 Problem Set 6 1. Why does the aggregate demand curve slope down (in Y-P space)? 2. Why does the AS curve slope up? 3. Suppose that firms become more optimistic about future earnings (i.e., business confidence increases). a. Show the immediate effect of the increase in business confidence in the income- expenditure and AD-AS diagrams. b. What is the effect on output and the price level? What can you say about the size of the output changes in the income-expenditure and AD-AS diagrams? c. (More difficult) Given the effects you described in part b, what is the effect on consumption. {Hint: there are two effects, but you may assume the price effect is small.} d. (More difficult) What must happen to private saving? Explain the mechanism by which private saving changes. {Hint: Model consumption as C=a+b(Y-T), where “a” and “b” have their usual interpretations. Now write the expression for private saving.}
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Unformatted text preview: 4. a. Suppose the economy begins at full employment. Then there is fall in consumer confidence. Using income-expenditure and AD-AS diagrams, show the immediate effects of the fall in consumer confidence. What will happen to the unemployment rate? b. Given your answer to part (a), what will happen to the economy over time? Illustrate your answer in an AD-AS diagram and explain the steps. c. Suppose the government wanted to take immediate action to restore the economy to full employment. Why might the government wish to take policy action rather than wait for the adjustment you described in part (b)? What fiscal policy options are available to the government to restore the economy to full employment? If the government takes the policy action you describe how will the economy compare over time to the situation you described in part (b)? 5. Redo question #4 under the assumption that consumer confidence increases....
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