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Part I: Analysis and problems: Answers to questions 1-3 do not need to be typed

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Part I: Analysis and problems: Answers to questions 1-3 do not need to be typed.

1. [8 points] In this question you are asked to Use the IS-LM model (diagram) and the AD-AS diagram to analyze the impact of a rise in Money Supply over time (from SR to LR). Assume that the economy starts in general equilibrium (GE). 

1. Show the impact of a rise in Money Supply over time on the IS-LM and AD-AS diagrams. Along with your diagram provide a detailed intuitive discussion [as done in lecture] of the impact on the whole economy. Clearly label the diagram to illustrate SR vs. LR movements!!! 
2. Provide an intuitive discussion on the impact of the shock in the SR only. Be complete. 
3. money supply Now provide an intuitive discussion of the impact of the shock in the LR only (i.e. discuss   what happens over time). Hint: price adjustment. Be complete. 
4. Use the time diagrams to show the impact of the shock over time on the following 3   variables: Consumption, real money supply, and the Price Level. 

2. [4points]UsetheIS-LMmodel(diagram)andtheAD-ASdiagramtoanalyzetheimpactofafallin capital taxes (i.e. tax on capital stock: ?) in the SR only. Along with your diagram provide a 

detailed intuitive discussion [as done in lecture] of the impact on the whole economy. Clearly label the diagram to illustrate SR movement. 

3. [8points]Considerthefollowingeconomy: C=1500+0.5(Y-T)-100r 

I=750-150r
T=200
G=600
L=0.5Y-250r
Ms=5000
P=2
Government Budget = T – G. (Expected inflation = 0) 

SHOW WORK for all calculations. 

1. a)  SolvefortheIScurveandtheLMcurve. 
2. b)  Solve for the equilibrium values of r and Y. [hint: Y is a whole number; note: do not multiply the   solution of r by 100; simply plug the solution to r directly as is into the equations to solve for Y] 
3. c)  Use the results from b) to solve for equilibrium C, I, and the Government Budget. 
4. d)  Now suppose that the full-potential level of output is equal to 5500 (i.e. Y = 5500). Draw the IS- LM diagram that correctly shows the IS, LM, and FE line give the information you have calculated above (in part b) and given that the full-potential level of output is known to be 5500. 

Impact of a rise in G. 

1. e)  Now suppose that G increases to 850. What is the impact on the equilibrium r, Y, C, and I. Calculate. 
2. f)  Discuss the impact of a rise in G on the economy, providing economic reasoning. No figure. 
3. g)  Lastly, if the full-employment level of output ( Y ) = 5500, did the rise in G (from 600 to 850)   bring the economy back to full-potential? Briefly discuss. 

Part II. Article ANSWERS to Question 4 MUST BE TYPED! 

4. [5 points] Read the article posted on iLearn: What We Do and Don’t Know about Discretionary Fiscal Policy. The article is required reading for the course. Then answer the following questions based on the article: (200-250 words – TYPED). 

1. a)  What are the challenges with using tax cuts to expand the economy? Under what condition can a tax cut be fairly expansionary? Discuss. 
2. b)  What are the challenges with using higher government spending to stimulate the economy? Discuss three (hint: starts on page 2!) 
3. c)  Whatistheconclusionreachedinthearticlewithrespecttousingfiscalvs.monetarypolicyto restore output in the economy? 

Extra Credit: 0.5 each. 2 max. 

Instructions: In order to get the extra credit points, you must attempt all questions in the Assignment. 

T/F 1. 

According to Keynesian Theory prices adjust slowly over time, while according to the Classical Theory prices adjust quickly over time. 

According to our models, a rise in G causes P to rise in the LR. 

In the LR, according to Keynesian theory, a rise in G does not affect output, but it does decrease I and C. 

General equilibrium occurs when the goods & service market, the market for money, and the labor market are all simultaneously in equilibrium.