Economics Assignment

By XYZ
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Question 1
Use IS-LM model to illustrate and explain the impact of an expansionary monetrary
policy on the level of output and the rate of interest. Make sure to explain how
changes in the interest rate and output are brought about.
An expansionary monetary policy leads to the rightward shift of the LM curve. This will
cause an increase in the excess supply of money at the initial equilibrium. This will
cause the rate of interest to fall. A decrease in the interest rate boosts up the investment,
thus causing aggregate demand to increase and the output increases.


Question 2
A 1-year Canadian bond with face value of $10,000 is purchased at $9,500.
a) Calculate the interest in Canada.
The interest in Canada is as follows:

Interest
rate
Output
i
i
Y
Y
E
E
IS
LM
LM
Increase in
money supply

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b) If the Canadian dollar is expected to depreciate against the US dollar by 1
percent over the next year, calculate the current interest rate in US. (Hint:
use the interest parity relationship.)
As per the interest rate parity condition:


c) How much could an American bond with the same face value as the
Canadian bond sell in the market?










Question 3
Suppose the economy is currently in recession, and the exchange rate is fixed. Using
the IS-LM model:
a) Explain and illustrate the economys adjustment (in the medium run) with
devaluation.
In the case of devaluation of the exchange rate in the case of the country facing
recession, the IS curve shifts right as the exports increases and imports decreases.
With increase in the interest rates, the money supply increases causing LM curve
to shift right under the fixed exchange rate system. Thus, output increases and the
interest rate is back to its initial equilibrium causing no change in the interest
rates.

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b) Explain and illustrate the economys adjustment (in the medium run)
without devaluation.
Recession causes a fall in the output casing decrease in the demand. This causes
IS curve to shift left and hence, rate of interest will fall. This fall in the interest
rate causes the government to decrease the money supply. This causes output to
fall and rate of interest remains unchanged in the medium run without
devaluation.
Interest
rate
Output
i
Y
Y
E
E
IS
LM
LM
IS
FE

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Question 4
Assume that the firms mark-up over the cost is 20%. And the wage-setting
equation is W=p (1-2u), where u is the unemployment rate.
a) Find the real wage rate implied by the price-setting equation.

b) Determine the natural rate of unemployment.

c) Plot the wage-setting and price-setting relationships on properly labeled
graph and identify the natural rate of unemployment on your graph.

Flaschel, P. and Krolzig, H. (2006), Chapter 2 WagePrice Phillips Curves and

Interest
rate
Output
i
Y
Y
E
E
IS
LM
LM
IS
FE

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