University of California, Davis ECN 101 - FALL 2012 Problem Set 6 Problem1)Using the IS-MP diagram, explain what happens to the economy if there is a temporary consumption boom that lasts for one period

Economics Mar 20, 2021

University of California, Davis

ECN 101 - FALL 2012

Problem Set 6

Problem1)Using the IS-MP diagram, explain what happens to the economy if there is a temporary consumption boom that lasts for one period.

Initially, suppose the FED keeps nominal interest rate unchanged.
Now suppose you were the chairman of the FED. What action would you take and why? (Refer to the IS-MP diagram)

Now consider the the full short-run model (that is, include the Phillips curve and allow the economy to evolve over time). Redo parts (a) and (b) above. Be sure to provide graphs for output and in?ation over time.

Problem 2: If your goal is to stabilize output, explain how you would change the interest rate in response to the following events (or shocks). In each case, show the e?ects on the economy in the short run using the IS-MP diagram.

Consumers become pessimistic about the state of the economy and future productivity growth.
Improvements in technology increase the marginal product of capital.
A booming economy in Europe this year increases demand for US goods.
A housing bubble bursts. Housing prices decline by 20 percent, and new homes sales drop sharply.

Problem 3: Suppose the slope of the Phillips curve, i.e. the parameter v¯,

increases. How would the results di?er from the Volcker disin?ation example considered in this chapter? What kind of changes in the economy might in?u- ence the parameter v¯?

Problem 4: Suppose European and Asian economies fall into a recession and reduce their demand for US goods for several years. Using the AS-AD frame- work, explain the macroeconomic consequences of this shock, both immediately and over time.

Problem 5: a) Why does the AS curve slope upward?

If the AS curve were more steep, how would the economy respond di?er- ently to aggregate demand shocks (i.e. shocks to a¯)?
If the AS curve were more steep, how would the economy respond di?er- ently to aggregate supply shocks (i.e. shocks to o¯)?
What kind of changes in the economy would lead the AS curve to become more steep?

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