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tutorial9solutions - Suggested Solutions to EC2102...

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Suggested Solutions to EC2102 Macroeconomic Analysis I Tutorial 9, Week 13, April 11-15, 2011 Question 1 ( iii ) Suppose that today°s money supply rises from M s 1 to f M s 1 , which will turn out to be exactly large enough to restore equilibrium, so LM 1 shifts down to d LM 1 : IS 1 now intersects d LM 1 at ° b b Y 1 ; b b r 1 ± ; and we know that AD 1 shifts to the right to g AD 1 by ° b b Y 1 ° b Y 1 ± : At the original price level b P 1 ; aggregate demand exceeds aggregate supply, so price level is going to rise. But as price level rises, d LM 1 is going to start shifting upwards, from d LM 1 : This is a movement up the g AD 1 from point b. We also move upwards along the AS 1 curve from point c as price rises since we°re moving down the N d 1 curve. Equilibrium is restored when IS 1 intersects the new g LM 1 at ² e Y 1 ; e r 1 ³ , and g AD 1 intersects AS 1 at ² e Y 1 ; e P 1 ³ : In the labour market, N s 1 ( e r 1 ) shifts to the left as real interest rates have fallen until N s 1 ( e r 1 ) . Furthermore, the rise in price level is su¢ cient to drive down real wages till
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