IS-LM Model

Freeland, a country in a faraway galaxy, anticipates being hit by rough weather in the coming few years. This is expected to decrease the future productivity of capital, and as a result, businesses in Freeland have less desire to invest. This question will help you analyze the effect of this anticipated shock on future productivity.

The Freeland economy is described by the following set of equations.

Goods Market

1. Goods Market Equilibrium Condition:=++
2. Y=C+I+G
3. Consumer Demand:=0.5()
4. C=0.5(YT)
5. Investment Demand:=6050
6. I=60Z50r
7. Government Budget:==400
8. G=T=400

Money Market

1. Money Market Equilibrium:/P = L(Y, +^e)
2. Real Money Demand:(, +^e) = 0.550
3. Money Supply:=480

Labor Market

1. Full-Employment Output:=500

The variable Z captures the anticipated shock to future productivity. If they become pessimistic, Z goes down. If they become optimistic, Z goes up.

1. Derive the IS curve for any given Z.
2. Derive the LM curve.
3. Suppose that the economy has been at the long-run equilibrium with=1.5
4. Z=1.5.Find the corresponding long-run equilibrium values of output, interest rate, and the price level.
5. Suppose that due to the anticipated future shock, Z decreases to=1
6. Z=1. Compute the short-run equilibrium values of output, real interest rate, and the price level.
7. Suppose that Z remains at=1
8. Z=1.What are the new long-run equilibrium values of output, real interest rate, and the price level?
9. Using the IS-LM-FE model, show the effect of the anticipated future shock graphically. On your graph, show the initial long-run equilibrium, the short-run equilibrium, and the new long-run equilibrium.