Question 7

6. Natural disasters: Suppose a large earthquake destroys many houses and build. ings on the West Coast but fortunately results in little loss of life. Show how to think about this event using the IS curve. Explain how actual output, potential output, and short-run output are affected in the short run, and why. 7. GDP and government purchases (a FRED question): Using the FRED database, construct a graph containing two data series, one for real GDP ("GDPC1") and another for real government consumption and investment expenditures ("GCEC1"). Use the "Add Line" option to add a second variable to your graph. Also, under "Format" for the government purchases variable, select the "Right" box for "Y Axis Position" so that the two series will be plotted close together. Then complete the following exercises: (a) Display the graph for the period 2004 to the present. (b) How did government purchases and real GDP co-move during and after the Great Recession? (c) Provide two alternative (and conflicting!) interpretations of these data, one suggesting that the rise in government purchases had a negative effect on the economy, and the other suggesting it had a positive effect. (d) Why is it difficult to determine which of these stories is most appropriate? (If you're curious, it is interesting to change the years on your graph to see how government purchases and GDP co-moved during earlier recessions.) 8. Consumption and the multiplier: Show how to derive an IS curve that includes the consumption multiplier. That is, show how to derive equation (11.16). Draw a graph of the original IS curve and the IS curve that includes the multiplier. Which one is flatter, and why? 9. Imports and the multiplier: The amount of goods that the U.S. economy imports might depend on the current state of the economy as well as on potential GDP. For example, when the economy is booming, imports usually