1. Answer all parts of this question. (a) In the monetary intertemporal model, suppose that the money supply is fixed for all time. Determine the effects of an increase in the capital stock on current equilibrium output, employment, the real wage, the real interest rate, the nominal interest rate, and the price level. Give the economic intuition for these results. Explain your results with the aid of diagrams. (b) Suppose in the monetary small open-economy model that government expenditures decrease temporarily. Determine the effects on aggregate output, absorption, the current account surplus, the nominal exchange rate, and the price level. Give the economic intuition for these results. What difference will it make if the exchange rate is flexible or fixed? Explain your results with the aid of diagrams.
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(a) In the monetary intertemporal model, where the money supply is fixed for all time, an increase in the capital stock will have the following effects: Show more…
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Suppose the economy is in a long-run equilibrium. a. Draw the economy's short-run and long-run Phillips curves. b. Suppose a wave of business pessimism reduces aggregate demand. Show the effect of this shock on your diagram from part $a$. If the Fed under-takes expansionary monetary policy, can it return the economy to its original inflation rate and original unemployment rate? c. Now suppose the economy is back in long-run equilibrium and then the price of imported oil rises. Show the effect of this shock with a new diagram like that in part $a$. If the Fed undertakes expansionary monetary policy, can it return the economy to its original inflation rate and original unemployment rate? If the Fed undertakes contractionary monetary policy, can it return the economy to its original inflation rate and original unemployment rate? Explain why this situation differs from that in part $b$.
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In the accompanying diagram, the economy is in longrun macroeconomic equilibrium at point $E_{1}$ when an oil shock shifts the short-run aggregate supply curve to $S R A S_{2}$. Based on the diagram, answer the following questions. a. How do the aggregate price level and aggregate output change in the short run as a result of the oil shock? What is this phenomenon known as? b. What fiscal or monetary policies can the government use to address the effects of the supply shock? Use a diagram that shows the effect of policies chosen to address the change in real GDP. Use another diagram to show the effect of policies chosen to address the change in the aggregate price level. c. Why do supply shocks present a dilemma for government policy makers?
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