IS-LM-PC

Question 1

What does the IS-LM-PC relation seek to find

Answer 1

How is output, unemployment rate and the interest rate determined in the short-run and medium-run

Question 2

How is output determined in the short-run

Answer 2

Y = C(Y-T) + I(Y, r) + G
Y = output
C = consumption
I = Investment which is a function of output and the real interest rate
G = Government spending

Question 3

Relation between inflation and unemployment

Answer 3

Pi - Pi(e) = -Alpha(U - Un)
This is the equation for the Phillips curve

Question 4

Relation between unemployment and output

Answer 4

Ut - Ut-1 = -Beta(Gyt - Gy)
This is the equation for Okun’s law

Question 5

What is the graph like for IS-LM-PC model in the short-run

Answer 5

answer on a piece of paper

Question 6

How would the plan to reduce the government deficit impact the model in the short run?

Answer 6

• a government deficit suggests a fiscal contraction which is either an increase in T or a reduction in G
• This contraction will lower aggregate demand and thereby lowers output in the short run
• The is shifts from IS to IS’ and the new short-run equilibrium is A’
  -Show in graph on paper

Question 7

What about a plan to reduce the government deficit in the medium run?

Answer 7

-Because the central bank prefers price stability, so they counteract the contractionary policy with monetary expansion
-The adjustment from the short run to the medium run is that the economy moves from A’ to A’’
-goes back to output = natural level of output but now with a lower level of interest r’n
-So in med-run rn has now decreased as the natural rate of interest (prime) is lower than the natural rate of interest
-This change implies investment is now larger but consumption will decrease because taxes have increased

Question 8

What is a plan to reduce the government deficit

Answer 8

By decreasing government spending or increasing taxes or both

Question 9

What is fiscal consolidation?

Answer 9

reducing the deficit in the trade balance

Question 10

Draw fiscal policy analysis

Answer 10

Answer on paper