According to the Keynesian 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. In answering this question, use IS-LM–FE and AD-AS diagrams in the manner of Figures 12.3 and 12.4. 

a. Financial deregulation allows banks to pay a higher interest rate on chequing accounts. 

b. The introduction of debit cards greatly reduces the amount of money that people need for transactions. 

c. A severe water shortage causes sharp declines in agricultural output and increases in food prices. 

d. A temporary beneficial supply shock affects most of the economy, but no individual firm is affected sufficiently to change its prices in the short run. 

Figure 12.3

Figure 12.4

Transcribed Image Text:

FE LM' LM? 2. Price level adjusts 1. Money supply increase ro IS Y, Output, Y (a) IS-LM analysis Real interest rate, r 3. Price level adjusts LM? LM? FE LM' 2. Price level adjusts 1. Government IS2 purchases increase IS' (a) IS-LM analysis Output, Y Real interest rate, r I>