Practice Prelim 3 - CORNELL UNIVERSITY Professor Levon Barseghyan Econ 3140 Fall 2012 Sample Second Prelim The answers should be short and straight to

Practice Prelim 3 - CORNELL UNIVERSITY Professor Levon...

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1 CORNELL UNIVERSITY Professor Levon Barseghyan Econ 3140 Fall 2012 Sample Second Prelim The answers should be short and straight to the point. Use graphs when possible . First provide the answer, and then briefly explain how you got it. 1. IS-LM Model (60 points, 30 points for each sub-question) Consider the IS-LM model with sticky prices and sticky wages and consumption function as specified in class: C(Y-T, r), i.e. Ricaridian Equivalence does not hold.What is the impact of the following changes on short run economic activity - output, the interest rate, consumption, investment and national savings? a)Money demand falls. b)Government implements a tax cut. c)Government spending increases. d)Future profitability (marginal product of capital) rises. If for any of the five macro variables in question - output, the interest rate, consumption, national savings and investment - the answer seems ambiguous, state so clearly. Then either explain why or make an assumption that resolves the ambiguity. 3. IS-LM Model: Liquidity Trap (20 points) Suppose that the economy finds itself at a lower bound on the interest rate. (See the figure below). (10 points first each) a)Will expansionary monetary policy have an effect on output and the interest rate? b)Will an increase in government spending have an effect on the interest rate? Does the answer depend on the magnitude of the increase? r IS LM Y

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