3. Using diagrams, illustrate and explain how the efficacy of fiscal policy is dependent upon assumptions about - (a) the existence of a liquidity trap [25 marks] (b) the impact of the permanent income and life cycle hypotheses upon current consumption and consequently the multiplier [25 marks] (c) wealth effects [25 marks] (d) the price elasticity of demand for money and its effect upon the LM curve [25 marks]
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In this situation, individuals and businesses prefer to hold onto their money rather than investing or spending it. To illustrate this, we can use the IS-LM model. The IS curve represents the relationship between interest rates and output in the goods market, Show more…
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The accompanying diagram shows the current macroeconomic situation for the economy of Albernia. You have been hired as an economic consultant to help the economy move to potential output, $Y_{R}$. a. Is Albernia facing a recessionary or inflationary gap? b. Which type of fiscal policy-expansionary or contractionary-would move the economy of Albernia to potential output, $Y_{P} ?$ What are some examples of such policies? c. Illustrate the macroeconomic situation in Albernia with a diagram after the successful fiscal policy has been implemented.
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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