Name Date last 4 PSU ID Economics 304 Homework Lesson 9 67 points Instructions Please show all work or points will be taken off Good luck Consider the following model of the economy Production function Y AKN N2 2 Marginal product of labor MPN AK N where the initial values of A 8 and K 10 The initial labor supply curve is given as NS 20 9w Cd 401 50 Y T 500r Id 800 500r G 500 T 100 Md P 469 0 5Y 1000r Nominal Money supply M 4000 We assume that expected inflation is zero e 0 so that money demand depends directly on the real interest rate since i r 1 a 6 points Solve for the labor market clearing real wage w the profit maximizing level of labor input N and the full employment level of output Y Please show your work Draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including this initial equilibrium point as point A 10 points for completely labeled and correct diagrams b 4 points Derive an expression for the IS curve r in terms of Y Please show all work c 3 points Find the real interest rate that clears the goods market Please show all work d 3 points Find the price level needed to clear the money market Please show all work e 4 points Find the expression for the LM curve r in terms of Y Please show all work 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 1 SCENARIO 1 AN LM SHOCK S1 a 4 points Now suppose that here is a shock to real money demand so that the new money demand function is Md P 449 0 5Y 1000r Name and support two reasons why real money demand would change like this please do your best to relate your answer to recent real world events S1 b 6 points What is the new short run fixed price level expression for the LM curve Please show all work S1 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 lesson S1 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 lesson S1 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 our video lectures S1 f 5 points From the Fed s perspective is this long run adjustment in the general price level desirable noting that the Fed s target for inflation P 2 If it is not desirable then what can the Fed do to hit their inflation target Would they conduct open market purchases or open market sales Hint feel free to use the quantity theory of money and Milton Friedman s famous quote as part of your answer 2