Workbook For Chapter 7 Of Blanchard Macroeconomics. Problem 2 Spending shocks and the medium run a. Using the AS-AD model developed in this chapter, show the effects of an increase in consumer confidence on the position of the AD, AS, IS, and LM curves in the medium run. Assume the economy starts at Yn. Does it shift the IS curve or the LM curve? __________. In which direction? ___________. Draw this in the IS-LM model. Y is now ___________. Notice this is still the short run. Will the shift of this curve (either IS or LM) be reversed by an increase in prices in the medium run? __________. What does this change in the IS-LM model do to the AD curve?_________________________ Draw this in the AD-AS model. i Y P YThis is still the short run. Will the shift of the AD curve be reversed by an increase in prices in the medium run? (Recall the AD curve is a relation between P and Y) Explain why or why not. _____________________________ ___________________________________________________________________. Consider what happened to P and Y. What is the consequence of these changes in the labor market? What happens to Pe in the medium run? _______. Given your answer, what will happen to the AS curve? ___________________. In the medium run, Y – Yn = ____. Draw this in the AD-AS model. Compared to the initial position, the initial rise in consumer confidence caused P to ______________ and Y to ______________ in the medium run. Look back at your IS-LM diagram, where you found the short-run change in Y. How will the IS curve or the LM curve have to change over time so that, in the medium-run, the IS-LM model gives you the same equilibrium output as the AD-AS model? (Assume the change in consumer confidence is permanent.)_________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ What will happen to interest rates in the medium run?____________________. b. Do the same exercise for an increase in income taxes. Draw the effect of the tax increase on IS-LM diagram, in the short-run. P YDraw the effect on the AD curve. What happens to prices? __________. What will have to happen to Pe in the medium run? ____________. To the AS curve? ___________. Given the final positions for P and Y, what happens in the IS-LM diagram in the medium run? What will happen to interest rates in the medium run?____________________. Problem 3 Supply shocks and the medium run a. Suppose that, starting from Y=Yn there is an increase in unemployment benefits. This gives workers more bargaining power, and they demand higher nominal wages. To keep their markup constant, firms raise their prices. Real wages don’t change, but un is now ___________. Draw this on the WS-PS model. i YWhat are the implications of an increase in unemployment benefits on the AS-AD model? Draw what happens in the short run, when P > Pe (because firms raised their prices, as mentioned above). Eventually, price expectations adjust and P _____ (> or = or <) Pe. Redraw the AD-AS model for the medium run. What happened to output in the short run? ____________. In the medium run? _______________________________________________________________. Don’t forget to do the rest of the problems. Additional Problem with AD-AS Problem A: Analytical Exercise with the AD-AS model The money market is characterized by the following equations: Md / P =5Y − 1200i Ms = 10000 And the goods market is characterized by the following equations: I = 100 − 200i +0.1Y C = 120+0.4 (Y − T ) G = 400 T = 400a. Derive the AD-curve. To do this, first derive the IS equation, Y = ______________________________. Then the LM equation, i = ____________________________________________. Then plug LM into IS and solve for Y to get equilibrium output as a function of the price level, Y = ____________________________________________________. Explain the meaning of the AD curve and give the intuition for the sign of its slope. ______________________________________________________________ ___________________________________________________________________ ___________________________________________________________________. The labor market is characterized by the following equations: W/P = Pe/P (Z − 8 − 10u) Y = N Z =9 L = 600 m = 1 where Z stands for unemployment benefits, m for the mark-up of prices over wages, Pe for the expected price level, L for the total labor force, N for employment level and u for unemployment rate. b. Derive the AS-curve. (Hint: write down the short-run WS equation, plugging in Z and replacing u with 1 – Y/L. Then follow the beginning of chapter 7). Recall that the AS curve is a relation between the Price level and equilibrium output, P = ________________________________________________________________. Explain the meaning of the AS curve and give the intuition for the sign of its slope. ______________________________________________________________ ___________________________________________________________________ ___________________________________________________________________. c. What is the natural level of output in this economy? To find this, first note that in the medium run, P = ________. Then plug this into the WS equation(after plugging in Z and replacing u with 1 – Y/L), set it equal to the PS equation, and solve for Y, which gives you Yn= ________________________________________________________________. Explain the concept of natural level of output. ___________________________ ___________________________________________________________________ ___________________________________________________________________. d. What is the equilibrium output in the short run, if the Pe = 4? Show qualitatively with a graph. Because the actual derivation of the solution is rather complicated, we can save some time by simply graphing the equations. For this, it will be useful to fill this table out. Use the equations to find the values. AD AS P Y P Y 8 560 7 570 6 580 5 590 4 600 3 (Actually, the solution is that of a quadratic equation, not too big of a deal.) 7 6 5 4 3 8 560 570 580 590 600Explain