4. A large decline in government purchases: Suppose there is a large temporary decline in government purchases in the economy, financed by an unspecified decline in future lump sum taxes. (a) Analyze the effect of the shock in the labor market diagram of a standard DSGE model (with no sticky prices or wages). What is the effect on the real wage and employment in the short run? (b) How would your answer change if there are sticky prices? (c) Discuss how your answer relates to the impulse response functions shown in Figure 15.12. (Hint: That figure is for an increase in government pur- chases, so you need to switch the sign of the effects in that figure.) FIGURE 15.12 The Dynamic Effects of a Shock to Government Purchases Percent change Percent change 1 GDP 0.5- 0.5 0 0 Consumption -0.5- -0.5 -1 20 10 15 Quarters after the shock 0 5 Percent change 0.7 0.6 0.5- 0.4 0.3- 0.2 0.1 0 LL 5 Hours worked 20 10 15 Quarters after the shock 0 Percent change 0.4 0.3- 0.2- 0.1- 0 5 20 10 15 Quarters after the shock Inflation L 10 20 15 Quarters after the shock

4. A large decline in government purchases: Suppose there is a large temporary decline in government purchases in the economy, financed by an unspecified decline in future lump sum taxes. (a) Analyze the effect of the shock in the labor market diagram of a standard DSGE model (with no sticky prices or wages). What is the effect on the real wage and employment in the short run? (b) How would your answer change if there are sticky prices? (c) Discuss how your answer relates to the impulse response functions shown in Figure 15.12. (Hint: That figure is for an increase in government pur- chases, so you need to switch the sign of the effects in that figure.) FIGURE 15.12 The Dynamic Effects of a Shock to Government Purchases Percent change Percent change 1 GDP 0.5- 0.5 0 0 Consumption -0.5- -0.5 -1 20 10 15 Quarters after the shock 0 5 Percent change 0.7 0.6 0.5- 0.4 0.3- 0.2 0.1 0 LL 5 Hours worked 20 10 15 Quarters after the shock 0 Percent change 0.4 0.3- 0.2- 0.1- 0 5 20 10 15 Quarters after the shock Inflation L 10 20 15 Quarters after the shock

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

4. A large decline in government purchases: Suppose there is a large temporary
decline in government purchases in the economy, financed by an unspecified
decline in future lump sum taxes.
(a) Analyze the effect of the shock in the labor market diagram of a standard
DSGE model (with no sticky prices or wages). What is the effect on the
real wage and employment in the short run?
(b) How would your answer change if there are sticky prices?
(c) Discuss how your answer relates to the impulse response functions shown
in Figure 15.12. (Hint: That figure is for an increase in government pur-
chases, so you need to switch the sign of the effects in that figure.)
FIGURE 15.12
The Dynamic Effects of a Shock to Government Purchases
Percent change
Percent change
1
GDP
0.5
0.5-
0
Consumption
-0.5
15
20
10
Quarters after the shock
0
-0.5-
5
Percent change
0.7
0.6
0.5-
0.4-
0.3-
0.2
0.1
0
0
5
Hours worked
20
10
15
Quarters after the shock
5
Percent change
0.4
0.3-
0.2
0.1
0
0
5
10
15
20
Quarters after the shock
20
10
15
Quarters after the shock
Inflation

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