Answer the following attachments.
9. Consider the AD-AS model in a closed economy. Firms are perfectly competitive and the price level Pis flexible. Output Y is produced according to the production function Y = F(L), where L is employment. Employment is chosen by firms to maximize profits. (a) [3 marks] Show that the first-order condition for profit-maximizing labour de- mand is W/P = F'(L). Assume nominal wages W are contractually fixed at W = W, and that workers' desired labour supply (which increases with the real wage) is greater than firms' labour demand at the fixed nominal wage. (b) [4 marks] Assume the marginal product of labour is diminishing. Using a diagram to represent the labour market, show how the short-run aggregate supply curve is derived. (c) [4 marks] Use the AD-AS model to find the effects of a decrease in the money supply on GDP, prices, and unemployment. Are the predictions of the model consistent with Okun's law? Now suppose that firms have a fixed level of capacity to produce output. The marginal product of labour is assumed to be a constant A for employment up to L', where capacity is fully utilized, and zero for employment greater than L'. (d) [4 marks] How does the shape of the short-run aggregate supply curve in this special case differ from what you derived in part (b)? Explain. Maintaining the assumptions from part (d), suppose the economy initially has employment equal to (*. (e) [2 marks] Find the effects on GDP and prices of increasing the money supply. (f) [3 marks] Suppose the central bank's goals are high GDP and low goods prices. Can you conclude from your answer to part (e) that the central bank should reduce the money supply? [Hint: Consider separately the cases where P = W/A and P > W/A]Question 3 [Marks: 25! (1.3.1 The monetary transmission mechanism can be depicted in the form of a graph [1D] or using symbols. Explain, with the aid of symbols, the monetary transmission mechanism when interest rates increase [Note: Prices and wages are variable} (1.3.2 Explain, using the AllAS model, how the South African Government can use [15] fiscal policy as a tool to recover from the negative effects of this CUVIDl pandemic. lI"our answer must include the following: i The description of the type of fiscal policy required; {4} C An explanation of how the implementation of this tool will work their way through the economy to achieve the desired effect; {5} i The ADAS graph showing the implications of your recommendations. [5] Marks will be awarded for your ability to integrate theory with the scenario provided. 12. Consider a small open economy with fixed prices and wages. Consumption depends positively on disposable income, investment depends neg atively on the domestic interest rate, and net exports depend negatively on income and negatively on the nominal exchange rate (defined as the foreign-currency price of domestic currency) Suppose the government has persistently run a large budget deficit D = G - T, which has led to worries about the government defaulting on its bonds. There is perfect capital mobility, but because of fears of default, investors are willing to hold domestic bonds only if the interest rate / exceeds the foreign interest rate i" by a positive risk premium s. Balance-of-payments equilibrium therefore requires i = i' + s, which means the BP line in the IS-LM-BP diagram is horizontal at i* + s. The economy begins in internal (IS-LM) and external (BP) equilibrium running a current account deficit. Assume the government has a fixed exchange rate policy and adjusts monetary policy to support the fixed exchange rate. Suppose the government introduces fiscal reforms and begins to reduce its bud- get deficit D by raising taxes T. (a) [4 marks] Following the fiscal reforms, use the IS-LM-BP diagram to deduce whether the government must buy or sell domestic currency to maintain the fixed exchange rate. (b) [6 marks] Find the new point of internal and external equilibrium in the IS- LM-BP diagram. What is the effect of the reforms on GDP? Do they help in reducing the country's current-account deficit? (c) [5 marks] What difference would it make to your answers in part (b) if the government allows the exchange rate to float freely at the same time as in- troducing the fiscal reforms? Now suppose the fiscal reforms also have the effect of reducing fears of default, which implies a lower risk premium s. Continue to assume a fixed exchange rate. (d) [5 marks] Use the IS-LM-BP diagram to find whether or not this leads to a better outcome for output and a lower current account deficit compared to part (b).must be newly drawn by hand. Mark penalty imposed if any of these instructions are NOT followed strictly. Question 1 (12 marks) Suppose the following is the demand equation of the famous flower shop, Brighten in Hong Kong and the current price charged by Brighten is $600 for a bunch of roses: Qd = 5000- 2P where P is the unit price of a bunch of roses and Qd is the quantity demanded (in bunch of roses) (a) Use the midpoint method to calculate the price elasticity of demand if Brighten decreases the unit price of a bunch of roses from $600 to $400. Show your workings. (Round your answer in two decimal places). (5 marks) (b) Identify the type of price elasticity of demand and explain briefly whether you support the price adjustment of Brighten based on your findings in (a) from the perspective of Brighten.(7 marks) Question 2 (28 marks) Suppose the following is the market condition for the market of cupcake. Qd = 900- 20P, where Qd is the quantity demanded (in units) and P is the price (in dollar term). Qs = -600 + 30P, where Qs is the quantity supplied (in units). (a) Define market equilibrium. Calculate the equilibrium price and equilibrium quantity of the cupcake market. Show your workings. Round your answer in integers if applicable. (4 marks)
