Final Exam Questions ECON 304

Question 2 40 pts Discuss how the new classical economists (hint, island) addressed the fact that money is leading and pro-cyclical. Be extremely specific in the model that was developed (tell a story) and relate the assumptions in the model to the empirical fact above. Include a completely labeled AS - AD diagram in your answer and be sure to explain why output changes, given a change in the money stock. Be sure to refer to the Lucas aggregate supply curve to support your answer by starting at an initial equilibrium point A in both diagrams (Y =Y, P = P,. etc.) and then show the short- run as point B and the long run as point C. Be sure to explain why workers change their behavior and why firms change their behavior, as we did in our video lectures (feel free to use numbers like we did in the video lectures). In the last part of your essay, discuss what determines the power of monetary policy (in terms of changing output) in this model, what determines how long the short run is, and whether or not you believe that this model is a solid basis for conducting countercyclical monetary policy, i.e., is money neutral in this model or not? Finish the essay by commenting on the following: This model was developed back in the 1960s and 1970s and we are now in the 21st century. Do you believe the model is more relevant or less relevant today relative to when it was written? Explain. Note: You will upload this work, along with all the other questions, at the end of the exam. Enter the word "Finished" into the text-box below when ready to move on.

Now draw four separate diagrams: (40 points total) Top left: a desired savings equals desired investment (s4=1d), Top right: a FE - IS - LM diagram, Bottom left: a money market diagram, Bottom right: An AD - AS diagram, locating this initial equilibrium point as point A. BE SURE to LABEL all diagrams completely (10 points for each correctly drawn and labeled diagram...each diagram will have two different equilibrium points A and B) We now have numerous changes to our economic conditions (all is not constant). Think of all these changes happening together, that is, we go from one state of economic affairs to a different state of economic affairs. Below are the changes. e The labor supply changes and is now: N5 = 10 + 9w . e Kgoesup from9 to 10 f) (5 points) What could cause such a change in labor supply? Please give two specific and well supported reasons. Be sure to explicitly identify/choose one of your (two) reasons to use as a "relevant" shift variable in your graph. g) (5 points) Given the change in N° and K, repeat part a) (i.e., find the equilibrium levels of the real wage, employment and output). Add these results to your labor market and production function diagrams respectively and label as point(s) B. Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function. Given the change in labor market conditions / production function we have one other change and that is the investment function has changed and is now: o The desired investment function is now 19 = 1020 - 500r h) (5 points) What could cause such a change in the desired investment function? Please give two specific and well supported reasons. Be sure to explicitly identify/choose one of your (two) reasons to use as a "relevant” shift variable in your graphs. i) (5 points) Given this change in desired investment, solve for a "new" expression of the IS curve. j) (5 points) Given the change in desired investment and the change in'Y, solve for the new goods market clearing interest rate. k) (5 points) Given the change in Y and r, solve for the new (if applicable) general equilibrium price level (we assume that prices adjust immediately to their general equilibrium value)

o The desired investment function is now 19 = 1020 - 500r h) (5 points) What could cause such a change in the desired investment function? Please give two specific and well supported reasons. Be sure to explicitly identify/choose one of your (two) reasons to use as a "relevant” shift variable in your graphs. i) (5 points) Given this change in desired investment, solve for a "new" expression of the IS curve. j) (5 points) Given the change in desired investment and the change inY, solve for the new goods market clearing interest rate. k) (5 points) Given the change inY and r, solve for the new (if applicable) general equilibrium price level (we assume that prices adjust immediately to their general equilibrium value) Please locate this new general equilibrium as point B on all your diagrams. 1) (10 points) Using a generic user cost / desired capital stock diagram, show the movement from point A to point B. Please be sure to be consistent and use the same reason that you chose in part h). Explain exactly why the desired capital stock has changed the way it has. Be sure to label diagram completely. m) (5 points) Is the movement from A to B more consistent with Classical economic theory or Keynesian economic theory? Explain. Note: You will upload this work, along with all the other questions, at the end of the exam. Enter the word "Finished" into the text-box below when ready to move on.