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# ps8ans - Economics 202 Principles of Macroeconomics Name...

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Economics 202 Name: _______________ Principles of Macroeconomics Professor Melick Problem Set #8 Due Friday April 4, 2008 1. Numerical Problem #3 from Abel and Bernanke Chapter 10, found on page 392. ( ) () () () 250 0.5 500 250 500 250 0.5 0.5 500 250 500 0.5 500 1000 0.5 1000 500 0.5 0.5 0.5 500 0.5 500 0.5 500 0 0.5 500 0.5 500 1 dd d e SY CG Y Y T r G I r YY T r G r Yr G T rY G T I S M Yi Y r Y r Y P M P π =− −=− + ⋅ − − ⋅−= = − ⋅ − ⋅+ ⋅+ ⋅− = − ⋅ ⋅= − ⋅+− ⋅ ⋅= − ⋅+ − ⋅ = −⋅ = += + = ⋅= ⋅+ r 2 000 M L M P Set IS equal to LM to solve for the AD curve. 2 500 0.5 0.5 2 1.5 500 0.5 2 1.5 500 0.5 M YG TY P M T P M PA T + = =⋅ +⋅ = ⋅− − + ⋅ D Use the fact that in equilibrium 1000 = = Y Y to solve for the endogenous variables. () ( ) 2 2 7650 15300 17 1.5 500 0.5 1.5 1000 500 200 0.5 200 900 7650 50 0.5 500 0.5 1000 500 0.1 17 500 250 0.5 500 250 0.5 1000 200 500 0.1 600 250 500 250 500 0.1 200 d d M P T M rr P CY T r Ir ⋅⋅ == = − − + ⋅ ⋅⇒ = = =+ = =−⋅ = =

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For part b) we start with the AD formulation and the fact that in equilibrium 1000 = = Y Y to again solve for endogenous variables () ( ) 2 2 9000 18000 20 1.5 500 0.5 1.5 1000 500 200 0.5 200 900 9000 50 0.5 500 0.5 1000 500 0.1 20 500 250 0.5 500 250 0.5 1000 200 500 0.1 600 250 500 250 500 0.1 200 d d M P YG T M Yr rr P CY T r Ir ⋅⋅ == = ⋅− − + ⋅ − − + ⋅ =⋅ ⋅⇒ = = =+ −⋅ = =−⋅ = = Notice that money is neutral, as M increased by 17.65 percent so did the price level, leaving all real variables unchanged. For part c) we start with the AD formulation and the fact that in equilibrium 1000 = = Y Y to yet again solve for endogenous variables ) 2 2 7650 15300 18 1.5 500 0.5 1.5 1000 500 300 0.5 300 850 7650 75 0.5 500 0.5 1000 500 0.15 18 500 250 0.5 500 250 0.5 1000 300 500 0.15 525 250 500 250 500 0.15 175 d d M P T M P T r = −− + −−+ = = = = =
2a) Using the classical version of the IS/LM/FE graphical framework without misperceptions, as well as graphs for the goods, asset, and labor markets, illustrate and explain the short-run and long-run effect of a cut in the tax rate on labor income. In each of the four graphs show only three points, an initial general equilibrium before the tax cut (labeled point A), the short-run equilibrium after the change in the tax cut (labeled point B), and the new long-run general equilibrium (labeled point C). Please see Figure 2a. The cut in the tax rate on labor income is initially felt in 2 markets, goods and labor. In the goods market, the cut in the tax rate boosts consumption which leads to a decline in savings. Desired savings shifts to ' 11 dd SY CG = −− from = . In the labor market, the cut in the tax rate increases the opportunity cost of leisure but at the same time acts as an increase in income. If the substitution effect dominates the income effect, labor supply will increase. This is what I assume. You could assume that the income effect dominates, in

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ps8ans - Economics 202 Principles of Macroeconomics Name...

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