Advanced Macroeconomics

ECO 441 / Waters

Homework Assignment #1

1) Describe and show how, if at all, the following developments affect the IS and/or MP
curves:
a) Taxes fall.
b) Government purchases fall, and at the same time the Federal Reserve change its
policy rule to set a higher real interest rate at a given level of output than before.
c) The demand for money increases due to an exogenous change in consumer
preferences for holding real money balances for given levels of i and Y.
d) Investment demand becomes less sensitive to the interest rate.
2) Let NX be net exports as a function of the exchange rate . A higher indicates
appreciation of the domestic currency. Use the following model for the questions below.
Let inflation be fixed at = .
Y = CY + Ir + G + NX
r = r, Y
a) Should dNX be positive or negative? Give a brief intuitive explanation.
d
b) If the domestic currency depreciates, what will be the affect on output Y and the
interest rate r. Show using comparative statics and a graph.
c) Explain the result in b) if the monetary policymaker responds only to inflation,
meaning dr = 0?
dY
d) In a more complete model, name one other variable that might affect NX.

dC
dr

3) Use the following model where consumption respond to the interest rate such that
< 0. Let inflation be fixed at = .
Y = CY, r + Ir + G
r = r, Y

Explain how an increase in government spending G would affect the endogenous variables
Y, r. How is the answer different with the inclusion of r in CY, r. Explain using comparative
statics and a graph. (Hint: Consider how your answer changes if dC
= 0.)
dr
4) For Cobb-Douglas production Y t = FK t , L t = K t A t L t 1 such that 0 < < 1, show
that F K > 0 and F KK < 0. Given a brief economic interpretation of these statements.
Similarly, determine the sign of F LA and give a brief interpretation.