ECO 3203 /

1. Using the Aggregate Demand-Aggregate Supply logic of Chapter 10, suppose that at first, the economy is at long-run equilibrium, on both the short-run and long-run aggregate supply curves (in other words, unemployment is at the Natural Rate of Unemployment). Then, government spending rises with no change in taxes.

A. What happens in the short-run to output (Y) and the prices of goods?

Explain why using Aggregate Demand and Supply logic (you dont need to draw the graphs unless you want to).

B. In the short-run, is there a surplus or a shortage of goods? Is there a surplus or a shortage of labor? (No need to explain)

C. Because of the shortage/surplus in part B, what happens to the prices of goods as we move beyond the short run toward the long-run? What happens to the wages of workers? (no need to explain)

D. In the end, in the long-run, will the prices be higher, lower, or equal to what they were before anything changed? In the end, will unemployment be higher, lower, or equal to the Natural Rate of Unemployment? Explain your answer.

2A. Using the Keynesian Cross logic of Chapter 11, suppose that Government spending increases by $10. The marginal propensity to consume is 0.90. How much, overall, would incomes (Y) increase by? Explain your answer or show the equation(s) you used.

B. How much would consumption spending and private (household) savings change by?

HINTIn part A, you found the change in Y. Combining the change in Y with the MPC might be useful.

C. Suppose now that Investment spending increased by $10 instead. Again using the Keynesian Cross logic with an MPC of 0.90, how much would incomes (Y) rise by?

3A. Using the IS-LM logic of Chapters 11 and 12, suppose that Investment spending rises.

i. How does this shift the IS curve, if at all? (left, right, or no change)

ii. How does this shift the LM curve, if at all? (left, right, or no change)

iii. What happens to interest rates and GDP? Explain why that makes sense (I dont mean with the curves, but with your own logic).

B. Suppose, instead of the above, that the Federal Reserve raises the money supply.

i. How does that shift the IS curve, if at all? (left, right, or no change)

ii. How does that shift the LM curve, if at all? (left, right, or no change)

iii. What happens to interest rates and GDP? (No need to explain.).