Chapter 9 (Carlin & Soskice)

Q2: Answer the following questions about the supply and demand sides in the medium run model:

a) What does the ERU curve represent? What would happen to ERU curve if unemployment benefits were raised? What would you expect to happen to inflation?

b) What does the AD curve represent? Derive the AD curve graphically from the IS curve. [Hint: draw the IS diagram below the AD diagram and think about how changes in the real exchange rate affect the IS curve. To derive the AD, map the combinations of q and y on each IS curve at r = r*].

c)How does a rise in the world real interest rate affect the AD curve? What is the effect on the medium-run real exchange rate?