The University of the West Indies, St.

Augustine
The Department of Economics

ECON 2002: Intermediate Macroeconomics I

Tutorial Sheet # 3

1. Supposed there is an increase in the velocity of money caused by the increased use of
ATM machines.
a. How would prices and output be affected in the short run?
b. If the Central Bank's objective is to keep prices stable in the short-run, how
should it respond?

2. Assume that the long-run aggregate supply curve is vertical at Y=3,000 while the short-
rum aggregate supply curve is horizontal at P=1. The aggregate demand curve is Y=
2(M/P) and M=1,500.

a. If the economy is initially in long-run equilibrium, what are the values of P and
Y?
b. If M increases to 2,000, what are the new short-run values of P and Y?
c. Once the economy adjusts to long-run equilibrium at M=2,000, what are P and
Y?

3. Suppose an economy with sticky prices experiences a negative supply shock due to an
increase in energy prices. With the use of a properly labelled diagram illustrate and
explain the type of intervention the central bank may engage in so as to cause the
economy to return to long-run real GDP.

4. Why does the IS curve slope downward?

5. Why does the LM curve slope upwards?

6. In the Keynesian cross, assume that the consumption function is given by

C = 200 + 0.75 (Y – T)

Planned investment is 100; government purchases and taxes are both 100.

a. Graph planned expenditure as a function of income.

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 b. What is the equilibrium level of income?

c. If government purchases increase to 125, what is the new equilibrium income?

d. What level of government purchases is needed to achieve an income of 1,600?

7. Explain why the tax multiplier is smaller than the government-purchases multiplier.

8. Fill in blanks:

a) Keynesian Cross
b) Liquidity Preference Theory
c) Demand shock
d) Multiplier
e) Okun’s Law
f) Supply shock
g) Stabilization policy

i. When the Federal Reserve changes the money supply to offset an adverse supply
or demand shock and to keep output and employment at their natural levels, this is
an example of a ____________________________________.

ii. _____________________________ depicts a negative relationship between the

percentage change in GDP and the change in the unemployment rate.

iii. A sharp, sudden increase in the price of oil is an example of a

________________________________. The expanded availability of credit cards
may be viewed as a ____________________________________.

iv. According to the _________________________________________, people wish

to hold a smaller quantity of real money balances when the interest rate increases.

v. In the ____________________________________________ model, every $1

increase in government purchases increases equilibrium income by $1 times the
government purchases___________________________________.

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