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Macro7

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Macro7

  1. 1. INTRO TO MACROECONOMICSExercise 7 Twitter: @RajEconwww.rajchandeteaching@blogspot.comRaj.Chande@bristol.ac.uk
  2. 2. Q1 Equilibrium level of aggregate demand (AD) occurs when an economy’s real goods and capital goods markets are in equilibrium. Eqbm in goods market: Goods demanded = goods supplied, IS Curve gives interest rate (i), income (Y) combinations Eqbm in capital market: Money supplied = money demanded, LM curve gives i, Y combinations That’s your initial equilibrium. Disturbance: Price level (P) increases.
  3. 3. 1) CTD, TRANSITION TO NEW EQBM P increase, real quantity of money falls Money demand greater than supply, public sell bonds, interest rate increases and new eqbm is reached in capital goods market But now i has gone up, investment (I) will fall and eqbm AD must now occur at a lower Y and higher i. Now… here’s the focus of this question, how does the sensitivity of I to i influence the overall change in Y? Most of you too briefon this bit
  4. 4. BEST WAY IS TO COMPARE TWO EXTREMES A: Imagine if I was hugely sensitive to i, then a small increase in i would cause a massive fall in I and thus a large drop in Y would be required to reach equilibrium AD again. B: If I didn’t really budge, then once the public sell their bonds, that’s more or less the whole story. Yes, i goes up, but the subsequent change in Y would be very small. The question did ask you to focus on this ‘in particular’. So do that. Now think, what would the AD curves look like for A and B?
  5. 5. 2) AGAIN, ‘IN PARTICULAR’ If AD was shallower for A, then what does that tell you about the IS curve for A?
  6. 6. 3) JUST ALGEBRA, PG65 TELLS YOU HOW IS: Y = [c0+c1T + I(i, Πe) + G] / (1-c1) LM: Y = M / P.L(i) …and in AD eqbm, we know that Z = Y Remember, IS and LM on i, Y space, AD on P, Y Simply plug in the values you have been given and rearrange to derive the IS curve. Y = 2925 – 35000i …or more usefully…i = 0.08357 – (Y/35000)
  7. 7. LM CURVE We have H, we have c, we have θ …and we know M = H/[c+θ(1-c)], so M is 125 Again, just sub this in to your Md equation:Md/P = M/P = 125/P = 0.4Y-5000i Rearrange to get: i = [Y – (312.5/P)]/12500
  8. 8. NOW AD IS & LM cross at one combination of i and Y AD curve on space of P and Y, so let’s get rid of i We know from LM expression that:i = [Y – (312.5/P)]/12500 so sub into IS to get: Y = 2925-35000[Y-(312.5/P)]/12500 Y = 769.7358 + 230.26/P
  9. 9. 3)II) If Y = 1000 and our AD curve tells us that: Y = 769.7358 + 230.26/P then just plug in Y = 1000 to get P = 1 Then using either IS or LM to get i: 1000 = 2925 – 35000ii = 0.055 Now we know i, we can calculate price of bond
  10. 10. III) AND IV) If you couldn’t do these, try again. Any problems, come see me, though Nigel will post answers on BlackBoard soon.
  11. 11. 4) THE DOLLAR INDEX SINCE 1969

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