Consider an economy where we can describe the behaviour of aggregate macroeconomic variables using the monetary...

 

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Consider an economy where we can describe the behaviour of aggregate macroeconomic variables using the monetary model Using the money supply/demand diagram, we want to understand what happens to the economy if it gets hit by some shocks. Assume that the economy is initially in a competitive equilibrium and call it A in your diagrams. Let's suppose that the economy suffers a positive investment shock in the current period, i.e. firms become optimistic and increase their investment. a) Start from A and illustrate how the shock will affect the economy. Call this new equilibrium B. [Assume that the effect of the change in the interest rate on the money demand is stronger than the effect of the change in output]. b) After the shock has hit the economy, the government decides to reduce government spending from G to G2, with G2 < G. Explain, using equations and diagrams, how the economy will move from equilibrium B to a new equilibrium C. [Assume that the effect of the change in the interest rate on the money demand is stronger than the effect of the change in output]. c) If instead of reducing government spending, the government implements a reduction in the money supply, what do you predict will happen? Explain how we go from B to a new equilibrium D. Consider an economy where we can describe the behaviour of aggregate macroeconomic variables using the monetary model Using the money supply/demand diagram, we want to understand what happens to the economy if it gets hit by some shocks. Assume that the economy is initially in a competitive equilibrium and call it A in your diagrams. Let's suppose that the economy suffers a positive investment shock in the current period, i.e. firms become optimistic and increase their investment. a) Start from A and illustrate how the shock will affect the economy. Call this new equilibrium B. [Assume that the effect of the change in the interest rate on the money demand is stronger than the effect of the change in output]. b) After the shock has hit the economy, the government decides to reduce government spending from G to G2, with G2 < G. Explain, using equations and diagrams, how the economy will move from equilibrium B to a new equilibrium C. [Assume that the effect of the change in the interest rate on the money demand is stronger than the effect of the change in output]. c) If instead of reducing government spending, the government implements a reduction in the money supply, what do you predict will happen? Explain how we go from B to a new equilibrium D.

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a Starting from the initial competitive equilibrium A where the money supply equa... View the full answer