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# Economics 305 Spring 2012 Dr. Neri Problem Set No. 3 due in class on Thursday March 15, 2012. Late submissions and e-mail submissions will not be...

1. Suppose the economy is in long-run equilibrium. Now suppose that laws are passed banning labor unions resulting lower labor costs and the lower labor costs are passed along to consumers in the form of lower prices.
(a) Use the aggregate demand/aggregate supply model presented in Chapter 9 to illustrate graphically the impact in the short run and the long run of this supply shock. Be sure to label: (a) the axes; (b) the curves; (c) the initial equilibrium values; (d) the direction the curves shift; (e) the short-run equilibrium values; and (f) the long-run equilibrium values.

(b) Prepare three “time graphs” as presented in class to show the short-run and long-
run impacts on: (Y), (P) and unemployment.

2. For each of the following, draw a diagram to show how the curve or curves should shift in the IS-LM model of a closed economy with fixed prices, and explain in a sentence or two the reason(s) for the shift(s).

(a) An increase in government purchases (G) financed by borrowing(T does not
change)
(b) An increase in government purchases (G) financed by printing money
(c) An increase in government purchases financed by increasing taxes by the same
amount.

3) Consider an economy in the short-run with the price level P fixed at 1 (P = 1). Other relevant information is:
a) C = 100 + 0.75 * (Y – T)
b) I = 750 – 20 * r
c) T = 1000; G = 1000;
d) Y = C + I + G
e) (M/P)d= 0.4 * Y – 48 * i
f) Ms= 1,200
g) (M/P)d= Ms/P
h) Suppose investors and bond traders expect inflation, π e= 0, so that i = r.
(i) Calculate the IS curve. Solve for Y in terms of r.
(ii) Calculate the LM curve. Again, solve for Y in terms of r.
(iii) What are the short-run equilibrium values for Y, r, C, I, private saving, public saving,
and national savings.
(iv) Show that C + I +G = Y and that S = I
(v) Present a properly labeled IS-LM graph showing the equilibrium level of Y and r.
(v) What is the government spending multiplier when G increased by 200? That is, what
is deltaY/delta G?
(vi) Assume that G is back at its original level of 1000, but the money supply increases
by 200. By how much will Y increase in the short-run equilibrium?

4. Use the data from question (1) but let's make T a function of income (an income tax
rather than a lump sum tax). Let T = -100 + 1/3Y.
(i) Calculate the IS curve. Solve for Y in terms of r.
(ii) Calculate the LM curve. Again, solve for Y in terms of r
(iii) Solve for the short-run equilibrium values for Y, r
(iv) What is the government spending multiplier when G increased by 200? That is what
is deltaY/delta G? What happened and why?
Economics 305 Dr. Neri Spring 2012 Problem Set No. 3 due in class on Thursday March 15, 2012. Late submissions and e-mail submissions will not be accepted. 1. Suppose the economy is in long-run equilibrium. Now suppose that laws are passed banning labor unions resulting lower labor costs and the lower labor costs are passed along to consumers in the form of lower prices. (a) Use the aggregate demand/aggregate supply model presented in Chapter 9 to illustrate graphically the impact in the short run and the long run of this supply shock. Be sure to label: (a) the axes; (b) the curves; (c) the initial equilibrium values; (d) the direction the curves shift; (e) the short-run equilibrium values; and (f) the long-run equilibrium values. (b) Prepare three “time graphs” as presented in class to show the short-run and long- run impacts on: (Y), (P) and unemployment. 2. For each of the following, draw a diagram to show how the curve or curves should shift in the IS-LM model of a closed economy with fixed prices, and explain in a sentence or two the reason(s) for the shift(s). (a) An increase in government purchases (G) financed by borrowing(T does not change) (b) An increase in government purchases (G) financed by printing money (c) An increase in government purchases financed by increasing taxes by the same amount. 3) Consider an economy in the short-run with the price level P fixed at 1 (P = 1). Other relevant information is: a) C = 100 + 0.75 * (Y – T) b) I = 750 – 20 * r c) T = 1000; G = 1000; d) Y = C + I + G e) (M/P) d = 0.4 * Y – 48 * i f) M s = 1,200 g) (M/P) d = M s /P h) Suppose investors and bond traders expect inflation, π e = 0, so that i = r.
Answer the following: (i) Calculate the IS curve. Solve for Y in terms of r. (ii) Calculate the LM curve. Again, solve for Y in terms of r. (iii) What are the short-run equilibrium values for Y, r, C, I, private saving, public saving, and national savings. (iv) Show that C + I +G = Y and that S = I (v) Present a properly labeled IS-LM graph showing the equilibrium level of Y and r. (v) What is the government spending multiplier when G increased by 200? That is, what is deltaY/delta G? (vi) Assume that G is back at its original level of 1000, but the money supply increases by 200. By how much will Y increase in the short-run equilibrium? 4. Use the data from question (1) but let's make T a function of income (an income tax rather than a lump sum tax). Let T = -100 + 1/3Y. (i) Calculate the IS curve. Solve for Y in terms of r. (ii) Calculate the LM curve. Again, solve for Y in terms of r (iii) Solve for the short-run equilibrium values for Y, r (iv) What is the government spending multiplier when G increased by 200? That is what is deltaY/delta G? What happened and why?

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