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EC390 Lecture Notes - Lecture 1: Real Wages

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peargoldfish265
16 Jun 2016
School
WLU
Department
Economics
Course
EC390
Professor
Shia

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Document Summary

Chapter 5: the response of investment to fiscal policy, the is curve shifts left. To obtain the equilibrium interest rate, substitute for equilibrium y from part (b): i= b0+ b1y- b2i= b0+ (b1- b2d1/d2)*y+ b2(m/p)/d2. Thus, for investment to increase, the output effect (b1) must be smaller than the interest rate effect (b2d1/d2). Y=1100-2000i: m/p=1600=2y-8000i i=y/4000-1/5, substituting b into a: y=1000, substituting c into b: i=1/20=5, c=400; i=350; g=250; c+i+g=1000, y=1040; i=3%; c=410; i=380. A monetary expansion reduces the interest rate and increases output. The increase in output and the fall in the interest rate increase investment: y=1200; i=10%; c=450; i=350. A fiscal expansion increases output and the interest rate. The increase in output increases consumption: the condition was b1 must be less that b2d1/d2for a contraction in g to increase i, for the model above 0. 25 is equal to (1000)x( 2/8000). The condition is not satisfied and the reduction in g will not increase i.

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Related Questions

1. The Response of investment to fiscal policy

1a. Using the IS-LM diagram, show the effects on output and the interest rate of a decrease in government spending. Can you tell whay happens to investment? Why?

Now consider the following IS-LM model:

C=c0+c1(Y-T)

I=b0+b1Y-b2i

M/P=d1Y-d2i

1b. Solve for equilibrium output. Assume c1+b1<1

1c. Solve for the equilibrium interest rate.

1d. Solve for investment.

1e. Under waht conditions on the parameters of the model will investment increase when G decreases?

1f. Explain the condition you derived in part e.

1. For a closed economy, the IS curve describes short-run movements in an economy via which of the following?

a. Interest rate Investment Output
b. Interest rate Investment Output
c. Tax rate Consumption Output
d. Interest rate Investment Output
e. Tax rate Government expenditure Output

2. A key difference between the long run and short-run models is the assumption _____________ in the short run

a. of zero inflation
b. of perfect price flexibility
c. that unemployment always equals its natural rate
d. that the economy never deviates from its long-run equilibrium
e. of sticky inflation (inflexible prices)

3. If prices are sticky and the Fed raises the nominal interest rate (ceteris paribus), __________ and __________ in the short run.

a. the real interest rate remains constant; real output remains at potential
b. the real interest rate falls; short-run real output falls
c. the unemployment rate rises; short-run real output rises
d. the real interest rate rises; short-run real output falls
e. the real interest rate falls; current real output falls

4. According to the Phillips curve, if the current output is above potential output (a boom),

a. inflation rises.
b. inflation falls.
c. unemployment rises.
d. inflation is constant.
e. prices fall.

5. According to the Phillips curve, in general during a recession

a. inflation rises.
b. prices fall.
c. unemployment falls.
d. inflation is constant.
e. inflation falls.

Suppose that the economy is given by:

C = c0 + c1(Y −T)

I = b0 + b1Y −b2i
with 0 < c1 < 1, 0 < b1 < 1, (c1 + b1) < 1, 0 < b2 < 1, and G, T are exogenous constants.

(a) Derive an expression for equilibrium output.

(b) Derive ∂Y/∂i, and invert this expression so that it is now ∂i/∂Y (hint: (3/2)−1 = (2/3). This is the IS curve we derived graphically in class. What is it’s sign? What is the effect on output of a small increase in the interest rate?

(c) What happens to the slope of the IS curve if b2 increases? What happens to the slope of the IS curve if (c1 + b1) increases? What is the economic intuition behind this?

(d) Using the expression for equilibrium output you derived in part b, derive ∂Y/∂G and ∂Y/∂T. What are the signs of these derivatives? How much does output change (and in what direction) if there is a
small increase in G? How much does output change (and in what direction) if there is a small increase in T? Now suppose equilibrium in the goods market is given by: Y (Y,i,G,T) (+,−,+,−) = C(Y,T +,− ) + I(Y,i +,− ) + G
(e) Derive ∂Y/∂i, and invert this expression so that it is now ∂i/∂Y (hint: (3/2)−1 = (2/3). This is the IS curve we derived graphically inclass. Whatisthesignofthisexpression? Whatdoesthesteepness of the slope of the IS curve depend on? How do the terms in this expression relate to the parameters b2,b1, and c1 in the IS curve you derived in part b?

(f) Through which channels does the interest rate affect output (i.e. what is the effects of changes in the interest rate on C, I, and G )? (Hint: To answer this question, you could take partial derivatives of C, I, and G with respect to i; or simply infer this from your answer to part a. )