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Solution manual for macroeconomics exam

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a. IS relation: (negative) relation between Y and i obtained from the equilibrium condition in the

goods market

Y = 1100 2000i

M

c. Note that the equilibrium condition in the money market is P

= Y L(i). The question supposes

that the real money demand function is more concretely given as Y L(i) = 2Y 8000i so that

M

the equilibrium condition in the money market becomes P

= 2Y 8000i. If 5%, the real money

supply in the case of equilibrium in the money market would be:

M

= 2 1000 8000 0.05 = 1600

P

d. Equilibrium consumption: C = 200 + 0.25(Y T ) = 200 + 0.25(1000 200) = 400

Equilibrium investment: I = 150 + 0.25Y 1000i = 150 + 0.25 1000 1000 0.05 = 350

Y = C + I + G = 400 + 350 + 250 = 1000; yes, it is the same as the equilibrium output

obtained in (b).

e. In case the central bank implements an expansionary monetary policy by cutting the rate to

i = 3%:

Equilibrium output: Y = 1100 2000 0.03 = 1040 (from the IS relation in (a))

Equilibrium consumption: C = 200 + 0.25(Y T ) = 200 + 0.25(1040 200) = 410

Equilibrium investment: I = 150 + 0.25Y 1000i = 150 + 0.25 1040 1000 0.03 = 380

Y = C + I + G = 410 + 380 + 250 = 1040; yes, it is the same as the equilibrium output

obtained from the IS relation above.

M M

Equilibrium P

: From (c), we have P

= 2Y 8000i = 2 1040 8000 0.03 = 1840

M

All of Y , C, I, and P

increased due to the expansionary monetary policy.

Equilibrium output:

Y = 1100 2000i

Y = 1400 2000 0.05 = 1300

1

Equilibrium consumption: C = 200 + 0.25(Y T ) = 200 + 0.25(1300 200) = 475

Equilibrium investment: I = 150 + 0.25Y 1000i = 150 + 0.25 1300 1000 0.05 = 425

Y = C + I + G = 475 + 425 + 400 = 1300; as expected, it is the same as the equilibrium

output obtained above.

M M

Equilibrium P

: From (c), we have P

= 2Y 8000i = 2 1300 8000 0.05 = 2200

M

All of Y , C, I, and P

increased due to the expansionary fiscal policy.

P e F (u, z). On the other hand, we know the price function P = (1 + m)W . The former can be

W W 1

rearranged into P

= 1 u which is the wage-setting relation and the latter into P

= 1+m

which is the pricesetting relation.

W 1 1

a. P

= 1+m

= 1.05

= 0.952 (since m = 5%)

b. From the two relations, we obtain the equilibrium condition in the labor market as

1

1u=

1+m

from which the natural rate of unemployment is derived as

1 1

u=1 =1 = 0.048 = 4.8%

1+m 1.05

c. When m = 10%,

1 1

u=1 =1 = 0.09 = 9%

1+m 1.1

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