Many people believe Europe currently is experiencing a recession due to its policy of fiscal austerity....

   

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Many people believe Europe currently is experiencing a recession due to its policy of fiscal austerity. Use the IS-LM AS-AD model to analyze the short run and long run effects of a permanent fall in government spending. (Make the usual IS-LM assumption: Prices are completely fixed in the short run and completely flexible in the long run. Investment is a function only of the interest rate, consumption only a function of disposable income with a constant marginal propensity to consume.) a) (6 points) Draw the IS-LM and AS-AD graphs to show the short run and long run equilibria. Assume that prices are completely fixed in the short run. Be sure to label the 2 axes and curves, use arrows to show shifts in curves, and mark the equilibrium points: I for the initial equilibrium, 2 for the short run equilibrium, and 3 for the long-run equilibrium. b) (5 points) What happens to the following variables in the short run equilibrium you analyzed above? MC#9: interest rate: MC#10: investment: MC#11: real money demand: MC#12: consumption: a) rise b) fall c) no change d) ambiguous a) rise b) fall c) no change d) ambiguous a) rise b) fall c) no change d) ambiguous a) rise b) fall c) no change d) ambiguous MC#13: nominal GDP: a) rise b) fall c) no change d) ambiguous c) (5 points) Compare the long run equilibrium (point 3 on your graph) to the initial level before the shock (point 1 on your graph). For each variable, is the long run value the same as the initial level before the shock, higher than this, lower or ambiguous? MC#14: real GDP: a) same as initial b) higher c) lower d) ambiguous MC#15: interest rate: MC#16: investment: a) same as initial b) higher c) lower d) ambiguous a) same as initial b) higher c) lower d) ambiguous MC#17: price level: a) same as initial b) higher c) lower d) ambiguous MC# 18: nominal GDP: a) same as initial b) higher c) lower d) ambiguous Problem 2: IS-LM in the Short Run (14 points total) Korea. has been using expansionary monetary policy recently. Analyze the short run effects of a rise in money supply in the IS-LM model, as directed below. a) (5 points) Draw an IS-LM diagram for the short run. Be sure to label the axes and curves, and use arrows showing the direction the curves shift. Also mark the initial equilibrium as point '1', and the short-run equilibrium as point '2'. (Make the usual IS-LM assumptions as listed for problem 2 above.) Explain any curve shift briefly. Many people believe Europe currently is experiencing a recession due to its policy of fiscal austerity. Use the IS-LM AS-AD model to analyze the short run and long run effects of a permanent fall in government spending. (Make the usual IS-LM assumption: Prices are completely fixed in the short run and completely flexible in the long run. Investment is a function only of the interest rate, consumption only a function of disposable income with a constant marginal propensity to consume.) a) (6 points) Draw the IS-LM and AS-AD graphs to show the short run and long run equilibria. Assume that prices are completely fixed in the short run. Be sure to label the 2 axes and curves, use arrows to show shifts in curves, and mark the equilibrium points: I for the initial equilibrium, 2 for the short run equilibrium, and 3 for the long-run equilibrium. b) (5 points) What happens to the following variables in the short run equilibrium you analyzed above? MC#9: interest rate: MC#10: investment: MC#11: real money demand: MC#12: consumption: a) rise b) fall c) no change d) ambiguous a) rise b) fall c) no change d) ambiguous a) rise b) fall c) no change d) ambiguous a) rise b) fall c) no change d) ambiguous MC#13: nominal GDP: a) rise b) fall c) no change d) ambiguous c) (5 points) Compare the long run equilibrium (point 3 on your graph) to the initial level before the shock (point 1 on your graph). For each variable, is the long run value the same as the initial level before the shock, higher than this, lower or ambiguous? MC#14: real GDP: a) same as initial b) higher c) lower d) ambiguous MC#15: interest rate: MC#16: investment: a) same as initial b) higher c) lower d) ambiguous a) same as initial b) higher c) lower d) ambiguous MC#17: price level: a) same as initial b) higher c) lower d) ambiguous MC# 18: nominal GDP: a) same as initial b) higher c) lower d) ambiguous Problem 2: IS-LM in the Short Run (14 points total) Korea. has been using expansionary monetary policy recently. Analyze the short run effects of a rise in money supply in the IS-LM model, as directed below. a) (5 points) Draw an IS-LM diagram for the short run. Be sure to label the axes and curves, and use arrows showing the direction the curves shift. Also mark the initial equilibrium as point '1', and the short-run equilibrium as point '2'. (Make the usual IS-LM assumptions as listed for problem 2 above.) Explain any curve shift briefly.

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