PS4S - ECO 320L SPRING 2009 Problem Set 4 Solutions...

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ECO 320L SPRING 2009 Problem Set 4 – Solutions 5/1/2009 56 points Professor Beatrix Paal BRB 3.114 [email protected] (512) 475-8531 PROBLEM 1 (28 POINTS) The seasonal component of economic fluctuations is just as important as the cyclical component. This question asks you to investigate the effects of the increased demand for consumption around Christmas. Assume that people are willing to substitute leisure intertemporally, and that the money multiplier is constant. Assume also that expected inflation is given and is unchanging. a) (9 points) Under the above assumptions, illustrate the general equilibrium of the economy using the IS/LM/FE curves. Illustrate the corresponding equilibrium situation in the labor market, goods market and asset market. Mark the equilibrium values of the real interest rate, output, the price level, saving, investment, employment and real money balances with variables subscripted with 1 ( etc.). Make sure that the connections between the different figures are clear. 111 , , rYP ∗∗∗ (3 points) Show the initial effect of an increase in demand for consumption. Show the change in the market that is initially affected. (Which market is it and which curve shifts?) Illustrate the reflection of this initial change in the general equilibrium diagram. Make sure you connect the magnitude of the shift(s) in the different figures Starting from the initial equilibrium, the effect of an increase in desired consumption is a reduction in desired saving. This shifts the IS curve up. The new IS curve goes through the point , where represents the interest rate that would equilibrate the goods market in the new situation if there were no general equilibrium feedback effects from the other markets. 12 (, ) IS Yr 1/10
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ECO 320L Spring 2009, Professor Beatrix Paal 5/1/2009 Problem Set 4 -- Solutions Y r 1 IS FE * 1 () LM P 1 Y 1 r 2 IS r 2 IS w Y , IS 11 SY I D N 1 S Nr ∗∗ = , M L P 1 w 1 N 1 Y N N r r 1 r 1 r 2 IS r 21 1 1 M L P = 1 LY 1 M P 2/10
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ECO 320L Spring 2009, Professor Beatrix Paal 5/1/2009 Problem Set 4 -- Solutions b) (3 points) Assume we are in the classical world. In the general equilibrium diagram, mark the new equilibrium situation with variables subscripted 2. How is the new equilibrium attained? (Which curve shifts to bring the economy to general equilibrium?) General equilibrium is attained by an increase in the price level and a corresponding upward shift of the LM curve: Y r 1 IS FE 1 () LM P 1 Y 1 r 2 IS r 2 IS 2 r 2 Y 2 LM P c) (7 points) Once the new general equilibrium situation is attained, the effects of this for the various markets can be traced out. Show the implied effect on the goods market, labor market and asset market. Use variables subscripted with 2 to mark the equilibrium values of the real interest rate, output, saving, investment, employment and real money balances in these figures.
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This note was uploaded on 06/09/2011 for the course ECON 320 taught by Professor Azzamonti during the Spring '08 term at University of Texas.

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PS4S - ECO 320L SPRING 2009 Problem Set 4 Solutions...

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