Module 2a

Question 1

If it is an expansionary fiscal policy, what happens to the graph and what are its implications in an IS-LM Framework?

Answer 1

From the equilibrium, the IS curve would shift to the right while the LM curve doesn’t move, thus increasing output (y).

Graph analysis:
- This would mean that since output (y) increases, aggregate demand increases as well, which increases consumption and investments.
- Both output (y) and interest rate (i) goes up
- No change in the LM curve as there is only one policy that took effect (which is fiscal policy)

Interpretation/implication:
- Since there is an increase in govt expenditure, income would also increase, which would have an increase in demand for money

Question 2

What is the equation of the IS?

Answer 2

IS: Y = C(Y-T) + I(Y,i) + G

Question 3

What is the equation of LM?

Answer 3

LM: M/P = YL(i)
-> real money supply is equal to the demand for money (a function of real income and nominal interest rate)

Graph: It would be upward sloping

Question 4

Why is the LM curve upward sloping in this regard?

Question 5

In the medium run, prices are constant. True or False?

Answer 5

False. In the medium run, prices can also vary because if there is a change in production, the # of workers employed and the cost of their wages/salaries that are incurred by the firms would react, thus eventually affecting price.

Question 6

Since prices are not constant in the medium run, what happens when firms respond to an increase in demand? What are its implications to this?

Answer 6

Production increases, then employment increases, thus, lowering unemployment, which leads to higher wages (due to more demand in labor force) which forces firms to increase prices. Higher prices lead to workers asking for higher wages (wage negotiation).

Question 7

When demand increases, production increases as well (law of supply). With that, what would firms do to increase production?

Answer 7

They can either hire more workers or make their existing workers work overtime

Question 8

What is the equation of the labor force?

Answer 8

Employed + unemployed = labor force

Question 9

What does the labor force consist of?

Answer 9

Employed and unemployed

Question 9

What does lower unemployment mean? What does this mean with unemployment rate and wages?

Answer 9

Workers are in a better position to bargain for their wages since prices increased due to the increased purchasing power of workers. On the firm’s perspective, they would need to raise their wages to attract the unemployed if there is an increase in employment rate. This implication is the spiral effect.

Question 10

What is the relationship between unemployment rate and wages?

Answer 10

The unemployment rate and wages have a negative relationship. When unemployment rate decreases, wages increases and vice versa

Question 11

What happens when there is a decrease in demand for firms? What do these imply for workers?

Answer 11

Firms would hire fewer workers, stop hiring altogether, or lay off some workers. This would imply that there can be freeze hiring or laying off of workers since there will be fewer job openings when demand is lower

Question 12

When unemployment is high, the probability of workers losing their job is higher while the probability of find a job is lower. True or False? Why?

Answer 12

True

Question 13

When unemployed, there is a lower chance of finding a job while when employed there is a lower chance of losing a job. True or False? Why?

Answer 13

False

Question 14

What is reservation wage?

Answer 14

It is the wage when a worker is indifferent to working or becoming unemployed. It doesn’t matter if they get the job or not. Similar to a bare minimum wage for the worker

Question 15

How would a worker’s bargaining be affected?

Answer 15

Their nature of the job and the labor market conditions

Question 16

What is the equation of wages? What does this imply?

Answer 16

W = PeF(u,z) where W is wages, and Pe is the expected price. There is a negative relationship between unemployment and wages since there is a negative relationship between bargaining power and labor market condition.

Question 17

When unemployment is lower, wages would increase, but it would make it harder to bargain for an increase in wage. True or False? Why?

Answer 17

False

Question 18

Why should we consider price determining the wage to give to workers or for companies to pay us?

Answer 18

Workers’ income is affected by price changes and inflation. It would affect their purchasing power with their real wages because they care how many goods or services they can purchase with their salary

Question 19

What is z?

Answer 19

It is the catch all variable. It’s the variable that affects the effect of wages or add-on to the effect of wages

Question 20

Output is equal to employment and labor productivity. True or False? Why?

Answer 20

True as its equation is Y=AN or Y=N, assuming that technology is constant (A=1), ceteris paribus since Y=F(K,N,A,T)

Question 21

What is the price-setting equation? What does this imply?

Answer 21

P=(1+µ) W where µ is the markup of price over cost. This implies that it reflects the degree of market power of firms (if they are monopoly or many players in a perfectly competitive)

Question 22

What is the implication of markup under a perfectly competitive market and a monopoly?

Answer 22

Under a perfectly competitive market, markup would be lower since there would more players in the market competition with prices. Contrasting to monopoly, markup would be higher as they are the sole price makers in the market.