Introduction to Macroeconomics (ECONTWO)

Term/ Year: 3rd Term- AY 2012-2013

Problem Set 2

Question 1: General Equilibrium Model

The following equations describe a three- sectors economy with tax:
Consumption = 0.8Yd
Tax = 0.25
Gross private domestic investment = 900 50i
Public Services = 800
Transactions Motive = 0.25Y
Speculative Motive= - 62.5i
Money Supply = 500
1)
2)
3)
4)
5)

What is the equation that describes the IS curve?

What is the equation that describes LM curve?
What are the equilibrium levels of income and the interest rate?
How much will be the change in equilibrium income if government spending increases by 150?
How much will be the change in equilibrium interest rate, if government spending increases by 150?

*Again, this is just an easier version. Please bring Lecture 1 notes on the day we are going to answer this so I could discuss to
you some given (regarding goods and services market) that I gave in the 1st Exam so you could be reviewed and be prepared.

For Questions 3 and 4, I know that this is in the lecture notes but try to understand the reasons as explained in class. This
would help a lot in answering Question 4.
Question 2: AD- AS Model
Explain the reasons the aggregate demand curve slopes downward. Give an example of an event that would shift the
aggregate-demand curve. Which way would this event shift the curve?
Question 3: AD- AS Model
Explain why the long-run aggregate-supply curve is vertical. Explain why the short-run aggregate-supply curve is upward
sloping.
Question 4: AD- AS Model
Explain whether each of the following events shifts the short-run aggregate supply curve, the aggregate demand curve,
both, or neither. For each event that does shift a curve, draw a diagram to illustrate the effect on the economy.
a) Households decide to save a larger share of their income.
b) Palay crops suffer a prolonged period of disastrous heavy rains during the rainy season.
c) The election of a popular presidential candidate suddenly increases peoples confidence in the future.
Steps for Analyzing Macroeconomic Fluctuations
1. Decide whether the event shifts the aggregate demand curve or the aggregate supply curve (or perhaps both).
2. Decide in which direction the curve shifts.
3. Use the diagram of aggregate demand and aggregate supply to determine the impact on output and the price level.