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Chapter 22: Q 25. (page 583)

Suppose the MP curve is given by r=2+蟺and the IS curve is given by Y = 20 - 2r.

a. Derive an expression for the AD curve, and draw a graph labeling points at 蟺=0,蟺=4,蟺=8

b. Suppose that 位increases to 位=2. Derive an expression for the new AD curve, and draw the new AD curve using the graph from part (a).

c. What does your answer to part (b) imply about the relationship between a central bank鈥檚 distaste for inflation and the slope of the AD curve?

Short Answer

Expert verified

(a) Y=16-2蟺

(b) Y=16-4蟺

(c) It has a more harmful affect on the output level.

Step by step solution

01

Step 1. Given information

The MP curve isr=2+蟺

The IS curve is Y=20-2r.

02

Step 2. Explanation

(a)

Combining the IS curve equation and the MP curve equation can provide the AD curve expression.

Y=20-2rY=20-2(2+蟺)Y=16-2蟺

The output level can be obtained as,

Y=16-2蟺At蟺=0,Y=16-2(0)Y=16At蟺=4,Y=16-2(4)Y=8At蟺=8,Y=16-2(8)Y=0

03

Step 3. Explanation Part (b)

(b)

The new AD curve expression would be,

Y=16-4蟺

The output level can be obtained as,

At蟺=0Y=16-4(0)Y=16At蟺=4,Y=16-4(4)Y=0

04

Step 4.Explanation Part (c)

It shows a negative relationship between the slope of the AD curve and the responsiveness of the real interest rate to inflation rate. When the inflation rate increases along with an increase in 位it has a more harmful affect on the output level.

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Most popular questions from this chapter

Assume that the monetary policy curve is given byr=1.5+0.75蟺.

a. Calculate the real interest rate when the inflation rate is2%,3%,and4%.

b. Draw a graph of the MP curve, labeling the points from part (a).

c. Assume now that the monetary policy curve is given by r=2.5+0.75蟺.Does the new monetary policy curve represent an autonomous tightening or loosening of monetary policy?

d. Calculate the real interest rate when the inflation rate is2%,3%,and4%, and draw the new MP curve, showing the shift from part (b).

Consider the economy described in Applied Problem 23.

a. Derive expressions for the MP curve and the AD curve.

b. Assume that 蟺=2. What are the real interest rate and the equilibrium level of output?

c. Suppose government spending increases to $4 trillion. What happens to equilibrium output?

d. If the Fed wants to keep output constant, then what monetary policy change should it make?

Use an IS curve and an MP curve to derive graphically the AD curve.

What would be the effect of an increase in U.S. net exports on the aggregate demand curve? Would an increase in net exports affect the monetary policy curve? Explain.

Consider an economy described by the following:

C = \(3.25 trillion

I = \)1.3 trillion

G = \(3.5 trillion

T = \)3.0 trillion

NX = -$1.0 trillion

f = 1

mpc = 0.75

d = 0.3

x = 0.1

l = 1

r = 1

a. Derive expressions for the MP curve and the AD

curve.

b. Assume that p = 1. Calculate the real interest

rate, the equilibrium level of output, consumption,

planned investment, and net exports.

c. Suppose the Fed increases r to r = 2. Calculate the

real interest rate, the equilibrium level of output,

consumption, planned investment, and net exports

at this new level of r.

d. Considering that output, consumption, planned

investment, and net exports all decreased in part (c),

why might the Fed choose to increase r?
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