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Unformatted text preview: University of Toronto Macroeconomics, Theory and policy Masoud Anjomshoa Economics Department Solution set #5 Disclaimer: These solutions are just guidelines for you, and may NOT include a complete solution for the questions and problems in your homework, as you must present in your assignments and/or exams. In your solutions you must show your work, and demonstrate your line of thinking clearly. Please, always check my calculations for unintentional typos or miscalculations. Blanchard # 3. a) Z = C+ G + I Z =co +c1*(YT) +G + I Z = Y Z= Y Y = co +c1*(YT) +G + I Equilibrium output: ] I G T . 1 c c [ 1 c 1 1 Y * + + = Multiplier is 1/(1c1) b) Z = C+ G + I Z =co +c1*(YT) + G + b0+ b1 Y – b2 i Z = Y Z= Y Y = co +c1*(YT) + G + b0+ b1 Y – b2 i Equilibrium output: i 1 b 1 c 1 2 b ] G T . 1 c b c [ 1 b 1 c 1 1 Y + + = Multiplier is 1/(1–c1–b1) But 1/(1c1) < 1/(1c1b1), therefore the multiplier is larger and autonomous spending has a higher effect on output (at the same level of interest rate). The reason is that in this case when output (income) goes up due to any increase in autonomous spending, investment does up too. The increase in investment, in turn, causes another round of expansion of output. c) IS: i 1 b 1 c 1 2 b ] G T . 1 c b c [ 1 b 1 c 1 1 Y + + = LM: M/P = d1 .Y – d2 . i i = d1/d2 Y – 1/d2 M/P ] P M 2 d 1 Y 2 d 1 d [ 1 b 1 c 1 2 b ] G T . 1 c b c [ 1 b 1 c 1 1 Y + + = ] P M 2 d 1 Y 2 d 1 d [ 1 b 1 c 1 2 b ] G T . 1 c b c [ 1 b 1 c 1 1 Y + + = Equilibrium output: ] P M 2 d 2 b G T . 1 c b c [ ] 2 d 1 d . 2 b 1 b [ 1 c 1 1 Y + + + = d) so the Multiplier is ] 2 d 1 d . 2 b 1 b [ 1 c 1 1 . As it is seen the size of the multiplier depends on c1, b1, b2, d1, and d2 the parameters of the behavioral equations for consumption, investment, and the money demand. For example: If d2 is very big, i.e. the demand for money is very sensitive to interest rate: And/ or if d1 is very small, i.e. the demand for money is not sensitive to income: And/or if b2 is very small, i.e. the investment is not sensitive to interest rate: And/or if b1 is big, i.e. the investment is sensitive to income: Such that , ] 2 d 1 d . 2 b 1 b [ Then: 1 c 1 1 ] 2 d 1 d . 2 b 1 b [ 1 c 1 1 or multiplier in this case higher than the one in part (a).  Blanchard # 4. a) A decrease in government spending, G, leads to decrease in demand for goods, output and income. The later, in turn, decreases the demand for money, thus, more demand for bonds, which leads to higher price of bonds, which is equivalent to decrease in interest rate. Increase in income and interest rate have opposite effects on investment, therefore, in general the overall direction of change is unclear. effects on investment, therefore, in general the overall direction of change is unclear....
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 Spring '10
 MasoudAnjamshoa
 Macroeconomics, Monetary Policy, lm curve

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