SCENARIO #1 - AN IS SHOCK!

Suppose that the President and Congress pass a tax cut bill so that T falls by 40 (from 100 to 60)

S1a) (6 points)What is the new, short run (fixed price level) expression for the IS curve? Please show all work.

S1 b) (4 points) What is the short run, Keynesian (fixed price) level of equilibrium output and real interest rate?Please show all work.

Please label these new short run conditions to your four diagrams as point B. Be sure to label diagrams completely with the inclusion of all the relevant shift variables like we did numerous times in the video lectures.

S1 c) (4 points) In the short run, what is the value of the tax multiplier (Y/T)?

S1 d) (4 points) Find the real interest rate associated with the long run general equilibrium.

S1 e) (4 points) Find the new price level associated with the long run general equilibrium.

Please label these long run conditions to your four diagrams as point C. Be sure to label diagrams completely with the inclusion of all the relevant shift variables like we did numerous times in the video lectures.

S1 f)(5 points) Now we know that one of the Fed's mandates is price stability.What would the Fed have to do, in terms of open market operations, so that the price level remains at its initial value? Assume the money multiplier is 0.8. Please show your work.

SCENARIO #2 - AN LM SHOCK!

Let's return to our original conditions:Please write down the expressions for your ORIGINAL IS curve and LM curves.

IS: r = ___________________________

LM: r = __________________________

Now draw four separate diagrams: (40 points total)Top left:a desired savings equals desired investment (Sd= Id), Top right: a FE - IS - LM diagram,Bottom left:a money market diagram, Bottom right: An AD - AS diagram,locating this initial equilibrium point as point A.BE SURE to LABEL all diagrams completely (10 points for each correctly drawn and labeled diagram...each diagram will have three different equilibriums points A, B, and C)

SCENARIO #2- AN LM SHOCK!

S2 a) (4 points) Now suppose that there is a shock to expected inflation so that e= 0.04 (originally, before the shock e= 0.02)

Name and support two reasons why expected inflation might change like this.

S2 b) (6 points)What is the new, short run (fixed price level) expression for the LM curve? Please show all work.

S2 c) (4 points) What is the short run, Keynesian (fixed price) level of equilibrium output and real interest rate?Please show all work.

Please label these new short run conditions to your four diagrams as point B. Be sure to label diagrams completely with the inclusion of all the relevant shift variables like we did numerous times in the video lectures.

S2 d) (4 points) Find the new price level associated with the long run general equilibrium.

Please label these long run conditions to your four diagrams as point C. Be sure to label diagrams completely with the inclusion of all the relevant shift variables like we did numerous times in the video lectures.

S2 e)(4 points) Let us focus on the movement from point A to B (the short -run) in your money market diagram.Explain why (and in what direction) the real interest rate had to change to 'clear' the money market.Be as specific as possible as we talked about this a great deal in the video lectures!

S2 f)(5 points) Now we know that one of the Fed's mandates is price stability.What would the Fed have to do, in terms of open market operations, so that the price level remains at its initial value? Assume the money multiplier is 0.8. Please show your work.

S2 g)(5 points)What else could the Fed do, besides conducting open market operations,in order to for the price level to remain at its initial value? Please explain how this would work.