Week 6 Homework - Week 6 EC301 2 011 Problem 14-1(a-f 1 a...

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Week 6 EC301 2 011 Problem 14-1 (a-f) 1. a. Given that the interest rate has been 4 percent for the last ten quarters, then for IS curve I, real GDP equals 8,800 - 25(4) - 25(4) - 25(4) - 25(4) - 20(4) - 20(4) - 20(4) - 15(4) - 15(4) - 10(4) = 8,000. For IS curve II, real GDP equals 8,400 - 5(4) - 5(4) - 5(4) - 5(4) - 10(4) - 15(4) - 15(4) - 15(4) - 20(4) = 8,000. b. For IS curve I, real GDP in the first quarter equals 8,800 - 25(3) - 25(4) - 25(4) - 25(4) - 20(4) - 20(4) - 20(4) - 15(4) - 15(4) - 10(4) = 8,025. Using the same IS curve, it is easy to show that for quarters two through ten, real GDP equals 8,050, 8,075, 8,100, 8,120, 8,140, 8,160, 8,175, 8,190, and 8,200, respectively. For IS curve II, real GDP in the first quarter equals 8,400 - 5(3) - 5(4) - 5(4) - 5(4) - 5(4) - 10(4) - 15(4) - 15(4) - 15(4) - 20(4) = 8,005. Using the same IS curve, it is easy to show that for quarters two through ten, real GDP equals 8,010, 8,015, 8,020, 8,025, 8,035, 8,050, 8,065, 8,080, and 8,100, respectively. c. Real GDP increases by 200 billion for IS curve I. The increase in real GDP for IS curve II equals 100 billion. d. For IS curve I, it takes four quarters for real GDP to increase by 100 billion or one-half of the total increase in real GDP. For IS curve II, it takes seven quarters for real GDP to increase by 50 billion or one-half of the total increase in real GDP. e. IS curve I resembles the economy’s response prior to 1991. The increase in output in response to a decline in the interest rate is larger than for IS curve II and one-half of the total increase in output occurs much sooner with IS curve I as compared to IS curve II. IS curve II resembles the economy’s response to a change in the interest rate since 1991. The reasons why IS curve I resembles the economy’s response prior to 1991 is that its interest rate parameters for the first six quarters are larger than those of IS curve II, and it is only for that last quarter that IS curve I has a smaller interest rate parameter than that of IS curve II. These parameters reflect the fact that since 1991, the monetary policy effectiveness lag has been longer and the interest- rate multiplier has been smaller. f. The answers to Parts b through d indicate that for IS curve II, real GDP rises less than it does for IS curve I during any of the first seven time periods, for any given increase in the interest rate. Therefore,
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