Question N1. Countering a positive shock. Consider an economy described by the IS relationship. Suppose that its output is initially sitting at the value implied by the long-run trend, but then investor confidence in the economy grows. 1. Use graphs to show how is equilibrium output going to change as a result of the boost in investors' confidence (assume for this part that the interest rate stays the same). 2. How can the economy's output be brought back through a change in the interest rate? Illustrate your answer using the graph from the previous part. 3. Why might countering a positive shock be desirable? (Hint: recall our discussion of what determines production in the short run and the medium run.) Question N2. Shocks and the strength of their impact. Suppose we are considering two economies A and B. Both economies are described by the IS relationship and are identical in all respects apart from parameter by. Assume that in economy A it is by, and it is higher than that parameter in economy B (call it b6, 64 > 16). At some point consumer confidence falls in both economies to the same extent. In which direction are the economies' outputs going to change? In which economy is the change going to be more pronounced? Why so? Comment on your results using the interpretation of by in the IS relationship. Can you think of possible reasons that could explain different values of b4 and 6? Question N-3. Comparing fiscal multipliers. Use the IS relationship to derive the tax and government spending multipliers. Whose value is larger? Why do you think this is the case? Try to answer the question before doing any calculations by just looking into the IS equation (labelled (3) in week 2's lectures)