Exercises of Block 1

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Macroeconomics of Finance Exercises on AS/AD model and Phillips Curve 1 AS/AD model Ex 1 Consider the following economy: C = 110 + 0.8Yd T = 0.4Y I = 100 − 100i G = 640 M d = 0.25Y − 200i M d = real money demand M s = 2BM BM = 1365 BM = nominal base money w = 25 w = nominal wage Y/N = 5 Y/N = labour productivity Prices are set using a 50% markup over unit costs. Solve for the equilibrium levels of prices, output, interest rates, and employment. Solution P = 7.5, Y = 1600, i = 18%, N = 320. Ex 2 Take an economy where the following relations hold: C = 200 + 0.8Yd Yd = disposable income T = 0.2Y TR = 45 I = 100 − 160i G = 400 Ld = 0.25Y − 160i L d = real money demand BMN = 7260 BMN = base money in nominal terms c = 0.8 (currency-to-deposits ratio) r = 0.1 (reserves-to-deposits ratio) Average and marginal labour productivity are equal to 2, while prices are initially expected to be P e = 30. a) Find the analytical expressions for the AD and AS curves, and the equilibrium level of output and prices under the hypothesis that price setters apply a 50% markup over marginal costs and nominal wages are set following the equation w =P e [4 3 − 0.5 ( 1 − Y Yn )] , where Yn = 2000 is the natural level of output. b) Use a graph to discuss how the initial equilibrium changes if the central bank decides to raise base money by 10%. Discuss both the short and medium run outcomes. Solution Initial equilibrium: P = 30, Y = 2000 (i.e., it is a medium run equilibrium). After the monetary expansion prices and output will immediately increase to P′ = 30.38 and Y′ = 2068.3 > Yn. In the long run, real balances will revert to the initial level thanks to the adjustment in prices ( PMR = 33 , YMR =Yn = 2000). Does the monetary expansion affect the natural rate of interest? 1 Ex 3 Consider the…