section8 - Econ 100B Section 101 & 102 Summer 2009 UC...

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Econ 100B Section 101 & 102 Summer 2009 – UC Berkeley Phakawa On Jeasakul July 27, 2009 Practice Problems 1. IS-LM Model. Suppose that the economy is in general equilibrium. Because of ideological differences, one group of the President’s advisors suggests that he raise income taxes (Scenario #1) while another group suggests that he increase government purchases (Scenario #2). a. Based only on this information, use a single IS-LM diagram to accurately and clearly show: 1. The initial general equilibrium situation (in black), and 2. The effects on economic output and the real interest rate from: Implementing Scenario #1 (in red) and Implementing Scenario #2 (in blue). b. Provide a brief economic explanation for the changes you showed in your diagram above as well as the adjustment process that the economy undergoes with respect to economic output and the real interest rate for each of these two scenarios. c. After these fiscal policy choices have been implemented, the Federal Reserve follows a stabilizing policy, i.e., it uses monetary policy to keep economic output at its general equilibrium level. Show how this policy affects Scenario #1 (in green) and Scenario #2 (in brown). d. For each of the following variables, indicate whether it is higher under Scenario #1, Scenario #2, or whether it is the same after both the fiscal and monetary policy changes have taken place. Also provide a brief explanation of why. 1. Income: 2. Interest rates: 3. Consumption: 4. Investment: 5. Government purchases: 6. Tax revenues: 7. Private saving: 8. Public saving: 9. Employment: 10. The unemployment rate: 11. The demand for money: 12. The supply of money: 2. IS-LM and AD-AS Models. Assume that the economy is in general equilibrium, and that any adjustment to long-term equilibrium takes 4 years. Suppose that the government then reduces income taxes while the central bank increases the money supply and that the effect on economic output from the fiscal policy change is larger than from the money policy change. a. Based only on this information, use IS-LM and AD-AS diagrams to accurately and clearly show: 1. The initial general equilibrium situation (in black),
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2. The short-run effects on economic output, the real interest rate, and the price level from these policy changes (in red), 3. The effect on economic output, the real interest rate, and the price level during the adjustment process (in blue, green, and brown), and
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section8 - Econ 100B Section 101 & 102 Summer 2009 UC...

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