Name Date last 4 PSU ID Economics 304 Homework Lesson 9 92 points You need to show your work not just the final answer Use the template to complete your work or points will be taken off Please put your name and PSU ID number at the top of the page Save the file on your computer PDF is the only format allowed and then upload it to the Canvas dropbox for this homework assignment Be sure your assignment is all on one file Failure to submit a single file will result in points being deducted 1 Consider the following model of the economy where the initial values of A 6 and K 10 The initial conditions in the goods market are as follows G 100 T 100 The initial conditions in the asset market are as follows L 78 0 5Y 1000 r e Nominal Money supply M 1800 Expected inflation is equal to 2 e 0 02 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 w N 1 Y b 10 points 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 2 c 4 points Derive an expression for the IS curve r in terms of Y Please show all work IS Equation d 3 points Find the real interest rate that clears the goods market Please show all work 3 r P e 3 points Find the price level needed to clear the money market Please show all work f 4 points Find the expression for the LM curve r in terms of Y Please show all work LM Equation 4 g 40 points 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 1 AN LM SHOCK SRAS SRAS 5 1 Knowing the equation for money multiplier which is 1 reserve ratio We see that money held in reserves above the required has a great propensity to earn banks additional income 1 They can change the nominal supply by paying interest on reserves this would be used in order to entice banks to hold onto reserves as we learned in lecture relating to 2008 They can also change the discount rate which is the rate at which banks borrow from the federal reserve By decreasing the rate it would entice banks to borrow larger amounts from the Fed and increase the money supply S1 a 4 points The Fed decides to conduct open market purchases equal to 50 Assume that banks continue to hold zero excess reserves and the money multiplier is 2 Name two other ways the Federal Reserve could change the nominal money supply this way S1 b 6 points What is the new short run fixed price level expression for the LM curve Please show all work LM Equation 6 S1 c 4 points What is the short run Keynesian fixed price level of equilibrium output and real interest rate Please show all work Y 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 r 7 P 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 The money no longer clears at the original interest rate as shown in the graph where money supply outweighs money demand My speci c graphs are a great example of expansionary policy This causes a disruption in the non monetary asset sector where prices have to rise and real interest rate have to lower in order to market clear When supply outweighs demand households will nd non monetary assets attractive which results in what an mentioned above with prices rising and yields falling According to the sher equation holding in ation constant we get that as nominal interest increases decreases so does real interest It is worth noting that when clearing the market prices have to rise rates have to fall to market clear at the new output In this case we see households with more money than they want to hold originally 8