MACROECONOMIC

ECN 3102

ASSIGNMENT 1

PREPARED BY :

NAME : LUQMAN BIN SULAIMAN

MATRIX NO. : 147501

COURSE : BACELOR BUSINESS ADMINISTRATION

DATE TO SUBMIT : 24 MARCH 2009

1. Draw a saving and investment diagram to show how each of the following changes shifts the IS curve.

a. Future income declines

r S(Y=4000) r

S(Y=5000)

D D’

F F’

I

IS1

IS0

Sd/Id Y

b. The future marginal productivity of capital declines

r S(Y=4000) r

S(Y=5000)

D D’

F F’

I

IS1

IS0

Sd/Id Y

c. Government purchases increase temporarily

r S(Y=4000) r

S(Y=5000)

D D’

F F’

I

IS1

IS0

Sd/Id Y

d. The effective corporate rate declines.

r S(Y=4000) r

S(Y=5000)

D D’

F F’

I

IS1

IS0

Sd/Id Y

2. For each of the following changes, which equilibrium curve (IS, LM, or FE) is shifted? Draw the change in the underlying demand or supply curves (for example, money demand and supply for the LM curve) and show how the equilibrium curve changes.

a. Expected inflation increase

r MS r LM1

LM2

6%

3% Md/P MD2 Md/P

MD1

1000 1300 M/P 4000 Y

& Md/P

b. The future marginal productivity of capital increases

r S(Y=4000) r

S(Y=5000)

D D’

F F’

I

IS1

IS0

Sd/Id Y

c. Labor supply decreases

R FE1 FE0

Y

Y1 Y0

d. Future income declines

r S(Y=4000) r

S(Y=5000)

D D’

F F’

I

IS1

IS0

Sd/Id Y

e. There’s a temporary beneficial supply shock

R FE0 FE1

Y

Y0 Y1

f. The nominal interest rate on money rises

r MS r LM1

LM2

6%

3% Md/P MD2 Md/P

MD1

1000 1300 M/P 4000 Y

& Md/P

3. Oil prices have risen temporarily, due to political uncertainty in the Middle East. An advisor to the Bank Negara suggests, “Higher oil prices reduce aggregate demand. To offset this we must increase the money supply. Then the price level won’t need to adjust to restore equilibrium, and we’ll prevent a recession.” Analyse this statement using IS-LM model.

r FE LM1

LM2 (P=100)

5% E M/P by 10%

3% F

IS

Y= 1000 1200 Y

The 10% in real money supply (M/P) does not shift IS or FE line because with Y and r held constant, a change in M/P does not affect Sd, Id, ND, NS or A.

Here P is assumed fixed at 100. The 10% in M/P shifts LM to LM2. LM shifts down because at any level

of Y, in money supply lowers market-clearing r.

However only the goods and assets market are in equilibrium at point F. The economy is not in general equilibrium.

When the economy is not in general equilibrium. o The economy rest at point F which is known as the short-run

equilibrium pointo Assets market (LM) adjusts the fastest while the labor market

(FE) is the slowest to adjust. The goods market (IS) adjusts moderately.

4. Describe the effects, in both the short-run and the long-run, of a decline in the money supply. Explain what happens to real output and the price level.

P LRAS

P1 H SRAS1

2. P 10%P2 E F SRAS2

AD1

1.M by 10%

AD2

Y

Y2 Y

In short run, P is fix. Firm demand and any output level is demanded, so short run curve is horizontal. In long run, after changing P, all market will be in the equilibrium point. firms produce the profit-maximizing level of output. Hence, in the long run, aggregate output, Y, equals its full-employment level, output. In the long run, firms supply output, it’s a full-employment. In the long run, firms supply Ŷ regardless of the price level, so the long-run aggregate supply (LRAS) curve is a vertical line at Y= Ŷ.