Question 1 (Exercise1from Chapter 11).(15POINTS- 3 pts each)

Answer:

Suppose the parameters of the IS curve are, and= 2%. Suppose further that initially the real interest rate R=2%. Explain what happens to short-run output (SRO) if:

a)The real interest rate rises from 2% to 4%.

Remember the equation for the IS curve:

Given the parameters that we are given, we have that ifincreases to 4%, the change in SRO(SHORT RUN OUTPUT)() will be given by:

With the information we're given, this becomes:

ANS:SHOW THE STPES/EQUATION TO ARRIVE AT THE ANSWER

b)The real interest rate falls from 2% to 4%.

Using the same equation above we obtain:

ANS:SHOW THE STPES/EQUATION TO ARRIVE AT THE ANSWER

c)increases by 1 percentage point.

We need to remember that the equation for GDP is given by:

So, each of the components of the exogenous expendituresenters with the same sign. In this case, we have thatcorresponds to the consumption component. Therefore, it enterswith a positive sign. In that sense, and using the equation:

We have that the change of SRO will be given by:

ANS:SHOW THE STPES/EQUATION TO ARRIVE AT THE ANSWER

d)increases by 1 percentage point.

By the same argument as above, we have that:

ANS:SHOW THE STPES/EQUATION TO ARRIVE AT THE ANSWER

e)decreases by 2%.

This situation is similar to the previous ones, except for the fact that imports enter the GDP equation with a negative sign, and therefore, they enter the exogenous componentalso with a negative component. In this case we have:

ANS:SHOW THE STPES/EQUATION TO ARRIVE AT THE ANSWER