SCENARIO #1 – AN IS Curve SHOCK! From General Equilibrium

QUESTION

SCENARIO #1 – AN IS Curve SHOCK! From General Equilibrium.Consider the following model of the economyProduction function: Y = A·K·N – N2/2Marginal product of labor: MPN = A·K – N.where the initial values of A = 6 and K = 10. The initial labor supply curve is given as: NS = 30 + 4wInitial conditions in the goods marketCd = 120 + .50(Y-T) – 500rId = 800 – 500rG = 100T = 100Md/P = 218 + 0.5Y- 1000(r + ?e)Nominal Money supply M = 3000Expected inflation is equal to 3% (?e = 0.03) Suppose that the consumption function has changed and is nowCd = 140 + .50(Y-T) – 500r a) Name and support two reasons why the consumption function would change like this.b) (What is the new, short run (fixed price level) expression for the IS curve? Please show all work.c) (4 points) What is the short run, Keynesian (fixed price) level of equilibrium output and real interest rate? Please show all work.Please label these new short run conditions to your four diagrams as point B. Be sure to label diagrams completely with the inclusion of all the relevant shift variables like we did numerous times in the video lectures.d) Find the real interest rate associated with the long run general equilibrium.e) Find the new price level associated with the long run general equilibrium.Please label these long run conditions to your four diagrams as point C. Be sure to label diagrams completely with the inclusion of all the relevant shift variables like we did numerous times in the video lectures. f) Now we know that one of the Fed’s mandates is price stability. What would the Fed have to do, in terms of open market operations, so that the price level remains at its initial value? Assume the money multiplier is 0.8. Please show your work.

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