SHORT TERM EQUILIBRIUM Flashcards
Setting the marginal propensity to consume at 0.80, the tax rate at 0.2 and the marginal propensity to import at 0.10 on the other hand, answer the following questions.
a) What does the budgetary multiplier (Y/G) measure? : triangle
It measures the cumulative change in output and income from a 1$ increase (in real terms) of government expenditures.
Setting the marginal propensity to consume at 0.80, the tax rate at 0.2 and the marginal propensity to import at 0.10 on the other hand, answer the following questions.
Setting the marginal propensity to consume at 0.80, the tax rate at 0.2 and the marginal propensity to import at 0.10 on the other hand, answer the following questions.
b) Calculate this budget multiplier.
1 /(1 -c(1-t) +m) in a closed economy so 1/ ( 1 -0.8x0.8 + 0.1) = 1/0.54 = 2.17
Setting the marginal propensity to consume at 0.80, the tax rate at 0.2 and the marginal propensity to import at 0.10 on the other hand, answer the following questions.
c) Why does this result differ from what would have been obtained under the IS-LM model? Explain.
In the IS-LM model there is an extra impact through the interest rate channel. Which reduces the impact of the multiplier.
Setting the marginal propensity to consume at 0.80, the tax rate at 0.2 and the marginal propensity to import at 0.10 on the other hand, answer the following questions.
d) Illustrate this difference in results with the IS-LM diagram.
The full multiplier impact is represented by the distance Y3 -Y1 which is bigger
Setting the marginal propensity to consume at 0.80, the tax rate at 0.2 and the marginal propensity to import at 0.10 on the other hand, answer the following questions.
e) If prices are sticky will the multiplier be bigger than if the aggregate supply curve is positively sloped?
Yes, it will. With a positively sloped aggregate supply there is an extra factor which reduces the multiplier impact, that is higher prices.
T OR F : a) A countercyclical fiscal policy could lead to higher interest rates during periods of expansion
False. By reducing expenditures, it pushes the IS curve to the left and exert downward pressure on interest rates.
T OR F : b) During a recession, if the government stimulates the economy by spending more, this will lead to a bigger employment increase if wages are flexible than if wages are rigid.
False. This policy shifts labour demand to the right but since wages are rigid there is no impact on wages while they would go up if wages were flexible with the result that employment increases more if wage are rigid.
T OR F : c) A negative aggregate demand shock will increase the real wage if wages are rigid and prices are sticky.
False. A negative aggregate demand shock shifts aggregate demand to the left reducing the price level if aggregate supply is positively sloped but not if prices are sticky. With wages being rigid, it means that W/P, the real wage, goes up is prices are flexible.
T OR F : d) Should the price of oil go down by 20 %, this could boost real GDP growth, employment and reduce the unemployment rate.
True. This is a positive supply shock. Aggregate supply shifts to the right and output goes up. Oil being complementary to labour, this will boost labour productivity and shift labour demand to the right, increasing employment and reducing unemployment.
a) Suppose that the government subsidizes hiring by introducing a job credit and that the Central Bank decides to lower its policy rate. What impact will this have on wages, employment and unemployment:
* When wages are rigid
* When wages are flexible
This policy shifts labour demand to the right. The subsidy encourages firms to hire more and the positive aggregate demand shock also shifts labour demand to the right.
* For rigid wages case : Wages stay the same, employment increases and it increases more than if wages were flexible. Involuntary unemployment drops.
* For the flexible wages case : Wages go up, employment increases and it increases less than if wages were rigid. Voluntary unemployment drops.
b) Suppose now that a boom allows firm to accelerate their adoption of new technologies but that at the same time, the government subsidize some people who were not in the labour force to now join the labour force. Can this lead to an increase of the unemployment rate (hint : use the labour market approach developed in class)?
First of all, accelerating the adoption of new technologies makes labour more productive and shifts labour demand to the right. For a given labour force, this sure will lead to less people being unemployed as employment goes up. But if the labour force increases more than employment, it could lead to more people being unemployed
By definition, the unemployment rate = U/LF. If U increases more than LF, then the unemployment rate will go up.
c) Suppose that we are now in recession and the government bonifies unemployment insurance. What impact would this have on disposable income and aggregate demand?
It is a transfer which increases disposable income. This will have a positive impact on consumer expenditures and aggregate demand.
