Econ%2B310%2Bw10%2BHW5%2BAnswers

Econ%2B310%2Bw10%2BHW5%2BAnswers - Econ 310 Homework...

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Econ 310 Homework Assignment 5 Answer Key Question Twenty-five Use the IS-LM model to predict the effects of the following exogenous changes on national income and interest rates: (i) An exogenous increase in investment demand The IS curve shifts to the right. National income rises and interest rates rise. (ii) An exogenous increase in the nominal money supply The LM curve shifts right. National income rises, and interest rates fall. (iii) An exogenous increase in money demand The LM curve shifts left. National income falls and interest rates rise. (iv) An exogenous increase in the aggregate price level The LM curve shifts left. National income falls and interest rates rise. (v) An exogenous increase in taxation The IS curve shifts left. National income falls and interest rates fall. Question Twenty-seven Consider the following exogenous shocks to the IS-LM model: (a) an increase in the nominal money supply (M); (b) an increase in government spending (G); (c) a technological development that improves the ease with which transactions can take place without holding money (i.e. a reduction in real money demand); and (d) an increase in union efforts to pressure firms to raise nominal wages. Contrast the effects of these shocks in the short run and the long run on real national income (Y), aggregate price level (P), interest rates (i and r), investment (I), real money supply (M/P), real wages (w/P) and employment. Be sure to explain why these effects occur. (a) an increase in the nominal money supply (M); The desire to increase the money supply necessitates the purchase of bonds in the open market. As bond prices rise, interest rates fall, and we will observe an increase in investment demand. In the short run, this increase in aggregate demand (AD) is satisfied out of firms’ inventories, and is reflected in an increase in national income.
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In the long run, firms will raise output price in response to the excess demand. This increase in the price level makes the real money supply contract, so the initial impact on the money market is reversed. Meanwhile, workers appreciate that their real factor payments have been eroded by increased prices. They will therefore negotiate for higher payments. This means that real wages will remain unchanged. Eventually, the real money supply, interest rates, investment and output will return to their
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Econ%2B310%2Bw10%2BHW5%2BAnswers - Econ 310 Homework...

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