Assume that the short-run equilibrium output and price combination Yeq,Peq is characterized by the point where the aggregate demand curve AD intersects the short-run aggregate supply curve SRAS. Aggregate demand AD is determined by IS-LM equilibrium. That is, aggregate demand is (Y,P) combinations consistent with market clearing in the goods market (IS) and in the money market (LM). The equilibrium equations for this economy are the following:
(SEE IMAGE FOR FORMULAS)
Y¯ = F (K¯,L¯) LRAS: Natural level of output
Y = Y¯ +a(P−EP) a > 0 SRAS: Aggregate Supply
Y = C(Y −T) +I(r) +G IS: Goods market clearing
M P = L(r,Y) LM: Money market clearing
(a) Show the short-run effect of and the channel through which an increase in the money supply M ↑ affects the equilibrium output Y, real interest rate r, and price levels P (draw only the graphs which have any changes on them; i.e., if there is no change to planned expenditure, don’t draw that graph).
(b) Show the short-run effect of and the channel through which an increase in government spending G ↑ affects the equilibrium output Y, real interest rate r, and price levels P (draw only the graphs which have any changes on them; i.e., if there is no change to planned expenditure, don’t draw that graph).
2. Chapter 14, Big AD and AS general equilibrium system (2 points): Assume thatthe short-run equilibrium output and price combination (Lq,Peq) is characterized bythe point where the aggregate demand curve AD intersects the short-run aggregatesupply curve SRAS. Aggregate demand AD is determined by IS—LM equilibrium. That is, aggregate de—mand is (Y, P) combinations consistent with market clearing in the goods market (IS)and in the money market (LM). The equilibrium equations for this economy are thefollowing: 17 = F (Ki) LRAS: Natural level of outputY = l7 +a (P — EP) a > 0 SRAS: Aggregate SupplyY = C(Y — T) +I(r) + G IS: Goods market clearingM— = L (r, Y) LM: Money market clearing (a) Show the short—run effect of and the channel through which an increase in themoney supply M T affects the equilibrium output Y , real interest rate r, andprice levels P (draw only the graphs which have any changes on them; i.e., ifthere is no change to planned expenditure, don’t draw that graph). (b) Show the short-run effect of and the channel through which an increase in gov—ernment spending G T affects the equilibrium output Y, real interest rate r, andprice levels P (draw only the graphs which have any changes on them; i.e., ifthere is no change to planned expenditure, don’t draw that graph).
