tutorial8solutions - Suggested Solutions to EC2102...

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Suggested Solutions to EC2102 Macroeconomic Analysis I Tutorial 8, Week 12, April 4-8, 2011 Question 1, PART A ( i ) Let W 1 be &xed at W 1 : Given price level b P 1 ; w 1 = W 1 b P 1 , know b N 1 and b Y 1 : So we have one point on AS 1 curve of & b Y 1 ; b P 1 ± To derive AS 1 curve, let price increase from b P 1 to e P 1 . Since W 1 is &xed at W 1 ; real wage falls to e w 1 = W 1 e P 1 ; so we move down N d 1 curve, and current employment rises to e N 1 , and output rises to e Y 1 : Hence we have another point on AS 1 curve of & e Y 1 ; e P 1 ± Continually changing prices, we can construct the whole AS 1 curve. ( ii ) Each point on AD 1 curve shows intersection of IS 1 and LM 1 . To construct the AD 1 curve, we have to let price vary. Recall that we drew LM 1 curve for a given price level b P 1 . Suppose that 1 intersects LM 1 at & b Y 1 ; b r 1 ± : We have one point on our AD 1 curve, & b Y 1 ; b P 1 ± : Now suppose that b P 1 falls to e P 1 : We know from above that LM 1 shifts downwards to g LM 1 . 1 now intersects LM 1 at & e Y 1 ; e r 1 ± : So we now have another point on our AD 1 curve, & e Y 1 ; e P 1 ± : Continually changing prices, we can construct the entire AD 1 curve. Question 2 ( i ) The LM curve, or Liquidity-Money curve, denotes equilibria in the money market, i.e., when nominal money supply equals nominal money demand at some real interest rate b r 1 , i.e., c M 1 = M S 1 = c M d 1 = b P 1 L & b Y 1 ;r 1 ± at real interest rate b r 1
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tutorial8solutions - Suggested Solutions to EC2102...

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