Question 5 (Macroeconomics, 30 points). Assume that, in the short run, there are two types of "shocks" which may cause the level of GDP to deviate from the long run, full employment level: (1) changes in autonomous investment spending; and (2) changes in autonomous money demand. Explain how you reached your results for all the parts of this question (a. through d.). You should feel free to use graphs or equations where appropriate. For all the parts of this question (a. through d.), analysis should be conducted for the short run only. a. (9 points) Suppose that the Fed sticks to money supply targeting: in response to any investment spending or money demand shocks, the Fed will leave the money supply at the predetermined and targeted level. How will this money supply targeting strategy affect the deviations of output from the full employment level under each of the two types of shocks?16 Problem: The following equations describe an economy C= 100 + 0.75Ya 1 = 50 -25r T = G = 50 Where C is aggregate consumption, Y' is disposable income, / is aggregate investment. 7 is taxes, G is government purchases and / is the rate of interest. Derive the IS curve for the economy.15. Problem: The following equations describe an economy: C= 10 + 0.5Y; I= 190- 20r. Derive the equation for IS curve.16. An increase in the aggregate price level, P, will most likely have which of the following effects? a, a rightward shift in the IS curve. b. a leftward shift in the IS curve. c. an upward shift in the LM curve. d. a downward shift in the LM curve. 17. Which of the following will occur if there is an increase in taxes? a. The IS curve shifts and the economy moves along the LM curve. b. The LM curve shifts and the economy moves along the IS curve. c. Output will change causing a change in money demand and a shift of the LM curve. d. Neither the IS nor the LM curve shifts. c. Both the IS and LM curves shift. 18. Suppose the current level of output and the interest rate are such that the economy is operating on neither the IS nor LM curve. Which of the following is true for this economy? a. Production does not equal demand. b. The quantity supplied of bonds does not equal the quantity demanded of bonds. c. The money supply does not equal money demand. d. Financial markets are not in equilibrium. e. all of the above. 19. Suppose the economy is currently operating on both the LM curve and the IS curve. Which of the following is true for this economy? a. Financial markets are in equilibrium. b. The quantity supplied of bonds equals the quantity demanded of bonds. c. Production equals demand. d. The money supply equals money demand. 92 | Page e. all of the above. 20. The IS curve will NOT shift when which of the following occurs? a. a reduction in government spending. b. a reduction in consumer confidence. c. a reduction in the interest rate. d. all of the above. c. none of the above. 21. Based on our understanding of the IS-LM model that takes into account dynamics, we know that a reduction in the money supply will cause: a a gradual increase in r and gradual reduction in Y. b. an immediate increase in r and no initial change in Y. c. an immediate drop in Y and immediate increase in r. d. none of the above. 22. Which of the following best defines the LM curve? a. illustrates the effects of changes in r on desired money holdings by individuals. b. illustrates the effects of changes in r on investment. c. the combinations of r and Y that maintain equilibrium in the goods market. d. the combinations of r and Y that maintain equilibrium in financial markets. 23. A reduction in consumer confidence will likely have which of the following effects? a. a rightward shift in the IS curve. b. a leftward shift in the IS curve.Write 7 for True and F for False against each of the following statements: 1. The concept of consumption function is given by Prof. J. M. Keynes. 2. The General Theory of Employment, Interest and Money was written by Prof. J. N. Keynes in 1936. 3. Consumption function shows the relationship between consumption expenditure and various level of disposable income. 4. Marginal propensity to consume varies between zero and infinity. 5. Average propensity to consume is the addition in consumption to the addition in disposable income. 6. The sum of average propensity to consume and marginal propensity to consume is always equal to one. 7. The sum of average propensity to consume and average propensity to save is always equal to one. 8. Autonomous consumption depends on level of income. 9. Friedman has given the famous psychological law of consumption. 10. "a" is autonomous consumption and "b" is the marginal propensity to consume in the consumption equation, C=a + bY. 1 1. Marginal propensity to consume is the slope of consumption curve. 12. When saving is equal to zero, consumption is equal to disposable income. 13. In the equation C= 500+ 0.80Y, marginal propensity to save is equal to 30 per cent. 14. In the equation C= 500 + 0.80Y, the marginal propensity to save is equal to 20 per cent. 15. In the equation C= 500 + 0.80Y, autonomous consumption is equal to 500
