Suggested Solutions to Assignment 2 - Department of Economics

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e) Using the same information as provided in part (d), in the long run what would happen to output, the real interest rate, the real exchange rate, consumption, investment, net exports, the nominal money supply, the price level, and the real money supply? Illustrate the new general equilibrium (that is, new long-run) values of output and the real interest rate in the IS-LM-FE diagram. Since at the short-run equilibrium the economy is operating above the full-employment level, there is an upward pressure on the price level. In the long-run, the price level will fully adjust and output will return to its full-employment level. So, at the new general equilibrium output will be equal to 1000. Substituting r = 0.19, M = 1024, and Y=1000 into the LM curve (Eq. (6)), we get 1024 5 0.19 = − + 200* P 5.12 ⇒ 0.19 = − + 2.5 P 5.12 ⇒ = 2.31 P ⇒ P = 2.2165. (1000) 2000 So, the new general equilibrium value of the price level is 2.2165 (the price level will increase in the long run). In the long run the nominal money supply will remain unchanged at its new level, 1024. At the initial general equilibrium, the real money supply was 924/2 = 462. At the shortrun equilibrium, the real money supply increased to 1024/2 = 512. At the new general equilibrium, the real money supply will be 1024 / 2.2165 = 461.9896 ≈ 462. This means that in the long-run the real money supply will return to its initial level. Substituting r = 0.19 and Y = 1000 into the IS curve (Eq. (4)), we get 810 5 6 0.19 = − e − 1000 500 5000 5000 ⇒ 0.19 = 1.62 − 0.001e −1.2 ⇒ 0.001e = 0.23 ⇒ e = 230. The new general equilibrium value of real exchange rate, e = 230 (the real exchange rate will remain unchanged in the long run). The new general equilibrium value of net exports, NX = 170- 0.08*1000-0.5*230= 170 – 80 – 115 = –25 (net exports will remain unchanged in the long run). Page 6 of 7 Pages
The new general equilibrium value of consumption, C= 200 + 0.6(1000 – 20-0.2*1000) – 200*0.19 = 630 (consumption will remain unchanged in the long run). The new general equilibrium value of investment, / = 300 – 300*0.19 = 243 (investment will remain unchanged in the long run). The results of this part of the question show that the monetary neutrality holds in the Keynesian long run. Figure 4(e) illustrates the new general equilibrium values of output and the real interest rate in the IS-LM-FE diagram. Page 7 of 7 Pages
Page 1 and 2: ECON 2450 Intermediate Macroeconomi
Page 3 and 4: S d = Y+NFP - C d - G = Y+0 - {200
Page 5: In the short run, the price level r

Suggested Solutions to Assignment 2 - Department of Economics

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