HW12 solutions - Homework 12 Solutions ECON 010 Fall 2011...

Info icon This preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
Homework 12 Solutions ECON 010, Fall 2011 Question 1: AD-AS Model and Money Market Analyze the credit card revolution in the 1980s. Suppose the demand for money goes down, because agents now have credit cards to carry out market transactions. a. Start in the money market and illustrate what happens to money demand and the quantity of money and interest rates in equilibrium. Answer: Introduction of credit cards will decrease the demand for money at any given interest rate and thus the Money Demand curve will shift in. As a result, the equilibrium interest rates will decline. However, the equilibrium quantity of money will stay the same (since MS is constant). b. Suppose that the economy is currently operating at potential GDP. Trace the development in the money market further into the AD-SRAS-LRAS diagram, assuming there is no long-run growth. Describe what happens to equilibrium GDP and prices. Answer: Since the equilibrium interest rates decline, Investment and Consumption will increase. There- fore, the Aggregate Demand curve will shift. In the short-run the economy will be producing at a level above Potential GDP (and thus, the unemployment will be be below the natural unemployment level) and the price level will be higher. c. Describe what will happen in the long-run to equilibrium level of GDP and prices. Answer: Since the prices are now higher, real wages are lower. Therefore, workers will demand higher wages and the supply for workers will shift in. The demand for workers will also shift up since demand depends on the price of the goods which the workers produce and the price is now higher. In equilibrium, the nominal wages will increase and employment will stay the same. Therefore, in the L-R in the AD-SRAS graph, SRAS will shift in to the point where the economy is now producing back at Potential GDP, but now the price level is higher. Question 2: AD-AS Model and Fiscal Policy Suppose that the economy is currently operating below potential GDP. The government has decided to cut taxes in an effort to increase output. Suppose that the government can calculate the exact amount by which it will need to cut taxes by in order to close the deflationary gap. 1
Image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
a. Describe what happens initially to Aggregate Expenditure when the government decreases taxes. Answer: When the government decreases taxes, the initial effect is an increase in Aggregate Expendi- ture. b. Describe what initially happens in the AD-AS model when the government decreases taxes.
Image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern