CHAPTER 2: THE IS – LM MODEL

1. Assume the following model of the economy:

Y=C+I+G
C = 120 + 0.5(Y-T)
I = 100 – 10r
G = 50
T = 40
MDr = Y – 20r
MS = 600
P=2
a. Derive the equation for the IS curve and LM curve. Graph both the IS and
LM curve
b. What are the equilibrium level of income and interest rate?

2. Suppose that the MDr = 1000 – 100r. The money supply MS = 1000 and P
=2
a. Graph the supply and demand for real money balances
b. What is the equilibrium interest rate?
c. Assume that the price level is fixed. What happens to the equilibrium
interest rate if supply of money is raised from 1000 to 1200
d. If the Fed wishes to raise the interest rate to 7%, what MS should it set?

3. Use the IS-LM model to predict the short-run effects of each of the following
shocks on income. In each case, explain what the Fed should do to keep income
at its initial level.

a. After the invention of a new high speed computer chip, may firms decide
to upgrade their computer systems.
b. A wave of credit card fraud increases the frequency by which people make
transactions in cash.
c. A best-seller titled Retire Rich convinces the public to increase the
percentage of their income devoted to savings.
 CHAPTER 3: MUNDELL - FLEMING MODEL

1. Explain briefly (2 or 3 sentences) why a monetary contraction for a small open

economy under fixed exchange rates will have no effect on real income.

2. If a small open economy with a flexible exchange rate is experiencing a

recession, what will automatically happen over time to its trade balance, foreign
exchange rate, and national output? Illustrate graphically.

3. Assume the following model of a small open economy with perfect capital
mobility and floating exchange system.
LM curve: Y = 200r – 200 + 2(M/P)
IS curve: Y = 400 + 3G -2T + 4NX – 200r.
NX = 200 – 100e
M = 100; G = 100; T = 100; P = 1; r* = 2.5%

a. What are the equilibrium level of income; exchange rate and net exports?
b. Assume that M increases by 50. Identify Y, e, NX at new equilibrium.
c. Instead of using monetary policy, how should the government change its
spending (G) to gain equilibrium Y in part b.
 CHAPTER 4: SHORT-RUN AGGREGATE SUPPLY

TRUE/FALSE
1. According to the sticky wage model, when the actual price level is greater than
the expected price level, the worker's real wage is higher than its target.

2. According to the sticky price model, the higher the proportion of firms with
fixed prices, the steeper the AS curve.

4. In the sticky-price model, the firm sets the flexible price based on the price of
sticky price firms.

5. If all firms are flexible price firms, the output is determined by the aggregate
demand curve.

6. Aggregate supply models show that when the real price level P is greater than
the expected price Pe, the output produced by firms increases
 CHAPTER 5: CONSUMPTION

1. In the Keynesian consumption model, why in the short run APC tends to
decrease as income increases?
2. According to the Fisher model, when does the optimal level of consumption for
a consumer occur?
3. Why the points inside or outside the budget constraint are not the optimal
consumption points?
4. What is the slope of the budget constraint?
5. Consumers have savings > 0 in the first period, if the real interest rate
increases, what will happen to C1 and C2?
6. How will future income increases affect the budget constraint?
7. How does an increase in interest rates change the budget constraint?
8. How is long-term stable APC explained by the life cycle hypothesis?
9. According to the permanent income hypothesis, is the change in Y in the long
run due to a change in permanent income or a change in temporary income?
10. If the household considers the government's tax reduction as temporary,
according to the permanent income hypothesis, will the household change its
consumption behavior?
 CHAPTER 6: ECONOMIC GROWTH

TRUE/FALSE

1. If the production function Y = F(K, L) with increasing returns to scale, we can

transform it to the form y=f(k), where y is output per capita, k is the investment
per capita.
2. When the steady state is reached, in the economy the difference between
depreciation and investment is the largest.
3. Country A has a larger population growth rate than country B, country A will
have higher consumption per worker in the steady state.
4. An economy with a lower saving rate than the Golden Rule, an increase in the
saving rate will immediately induce an increase in consumption per worker.
5. Slowing population growth and increasing the saving rate help sustain growth
in the long run.
6. Technological progress does not increase output per worker in the steady state
but increases output per efficient worker.

PROBLEMS

1. Given the production function Y= K2/3L1/3, s = 60%, depreciation rate

= 10%, n = 5%. Find the value of k*, y*, i*, c* at the steady state.
2. Given the production function Y= 8K1/2(EL)1/2 and the depreciation
rate = 10%; n=4%, g=6%. Find the saving rate s according to the Golden Rule.