ECON2102
Tutorial 7
Macroeconomics
1. The IS-Curve
a) Show how to derive an IS curve (follow step by step) that considers the con- sumption multiplier.
b) Draw a graph with the original IS curve and the IS curve that includes the multiplier. Which one is flatter and why?
2. Open economy
Suppose that the level of imports is related to current output as well as the level of potential output, in much the same way we modeled consumption in class. Let suppose imports are given by:
(1)
For simplicity, assume consumption does not depend on current output ( = 0).
a) Derive the IS curve for this new specification
b) What is the economic explanation for why the parameter shows up in the denominator of the new IS curve? Compare the effect on short-run output of an AD shock, with that obtained using the original IS curve. Explain what is going on.
3. Cash rate
Suppose the RBA, Australia’s central bank, announces that it is increasing the cash rate by 25 basis points (one-quarter of a percentage point). As a senior advisor of the Finance Minister, you are required to express your opinion about the effect of the monetary policy on economic activity in the short-run, explaining what is the transmission mechanism for monetary policy. (Hint: You can use the IS model to add discipline to your comment).
4. Consumption boom
You are advised that the economy will be subject to a temporary consumption boom after Australia opens its international borders. As a Senior Advisor of the PM you are requested to provide an opinion about the effects on the economy of this temporary shock that will last for one period only. (Hint: You can use the IS-MP model)
a) Initially, suppose the central bank keeps the nominal interest rate unchanged.
b) Now suppose the central bank responds by changing the nominal rate. How should it respond?
5. Unexpected shocks
Suppose the economy is hit by an unexpected oil price shock that permanently raises oil prices by $50 per barrel. That is a temporary increase in in the Phillips curve: the shock becomes positive for one period and then goes back to zero. (Remember, the shock affects the change in inflation.)
Using the MP-IS-PC short-run model, explain what happens to the economy in the absence of any monetary policy action. Be sure to include graphs showing how output and inflation respond over time.