1. The discovery of a new technology increases the expected
future marginal product of capital.
a. Use of the classical
IS-LM model to determine the effect of
the increase in the expected future MPK
on current output, the real interest rate, employment, real wages, consumption,
investment, and the price level. Assume that expected future real wages and
future incomes are unaffected by the new technology. Assume also that current
productivity is unaffected.
2. Use the IS-LM
model to analyze the general equilibrium effects of a permanent increase in the
price of oil (a permanent adverse supply shock) on current output, employment,
the real wage, national saving, consumption, investment, the real interest rate,
and the price level. Assume that, besides reducing the current productivity of
capital and labor, the permanent supply shock lowers both the expected future
MPK and households expected future
incomes. (Assume that the rightward shift in labor supply is smaller than the
leftward shift in labor demand.) Show that, if the real interest rate rises at
all, it will rise less than in the case of a temporary supply shock that has an
equal effect on current output.
3. Consider a business cycle theory that combines the
classical IS-LM model with the
assumption that temporary changes in government purchases are the main source of
cyclical fluctuations. How well would this theory explain the observed cyclical
behavior of each of the following
variables? Give Reasons for your answers.
a. Employment
b. The Real Wage
c. Average labor productivity
d. Investment
e. The price level
4. What does the Keynesian model predict about monetary
neutrality (both in the short run and in the long run)? Compare the Keynesian
predictions about neutrality with the basic classical model and the extended
classical model with misperceptions (Island Economy).
5.
According to the Keynesian
IS-LM model, what is the
effect of each of the following on output, the real interest rate, employment,
and the price level? Distinguish between the short run and the long run.
a.
Increased tax incentives for investment (the tax
breaks for investment are offset by lump-sum tax increases that keep total
current tax collections unchanged).
b.
Increased tax incentives for saving (as in part
(a), lump-sum tax increases offset the effect on total current tax collections).
c.
A wave of Investor pessimism about the future
profitability of capital investments.
d.
An increase in consumer confidence, as consumers
expect that their incomes will be higher in the future.
6. To fight an ongoing 10% inflation, the government makes
rising wages or prices illegal. However, the government continues to increase
the money supply (and hence aggregate demand) by 10% per year. The economy
starts at full-employment output, which remains constant.
A.
Using the IS-LM framework, show the effects of
the government’s policies on the economy. Assume that firms meet the demand at
the fixed price level.
B.
After several years in which the controls have
kept prices from rising, the government declares victory over inflation and
removes the controls. What happens?
7. Describe three alternative responses available to
policymakers when the economy is in recession. What are the advantages and
disadvantages of each strategy? Be sure to discuss the effects on employment,
the price level, and the composition of output. What are some of the practical
difficulties in using macroeconomic stabilization policies to fight recessions?