Aggregate Demand and Supply Model

Question 1

Extended Consumption Function

Answer 1

o C = C̅ + c(Y – T̅) – ɣCr
o ɣC measures interest sensitivity of consumption

Question 2

Extended Investment Function

Answer 2

o I = I̅ – ɣIr
o ɣI measures interest sensitivity of investment

Question 3

Extended Keynesian Equilibrium

Answer 3

Y = C̅ + c(Y – T̅) – ɣCr + I̅ – ɣIr + G̅

Question 4

Monetary Policy Reaction Function

On Formula Sheet

Answer 4

i = r * + π + α(π – π * )
o i is nominal interest rate
o r * is natural real rate
o α is sensitivity of central bank policy rate to inflation gap
o π * is central bank inflation target

Question 5

Phillips Curve

Answer 5

π = πᵉ – ϕ(u – u*) + ϵs

o πᵉ is inflation expectations
o ϕ is inflation sensitivity to labour market tightness
o ϵs is supply shocks

Question 6

Aggregate Demand Curve

Answer 6

Y – Y* = ϵD – ɣ(α(π – π*))

α: sensitivity of policy rate to inflation gap

ɣ: sensitivity of expenditure to interest

εD: demand shock

Question 7

Short Run Aggregate Supply Curve

On Formula Sheet

Answer 7

π = πᵉ + ϕβ(Y – Y*) + ϵs

Question 8

Long Run Aggregate Supply Curve

Answer 8

Vertical at Y = Y*