use the "Lucas Island Model" to provide an explanation as to why money is leading and pro-cyclical according to the New Classical Economists. Be sure to include a completely labeled AS/AD diagram and an explanation of what we mean exactly by a Lucas Aggregate supply curve (along with the intuition underlying it). Finish your essay by discussing whether or not money is neutral in this New Classical model and why.
use the "Lucas Island Model" to provide an explanation as to why money is leading and pro-cyclical according to the New Classical Economists. Be sure to include a completely labeled AS/AD diagram and an explanation of what we mean exactly by a Lucas Aggregate supply curve (along with the intuition underlying it). Finish your essay by discussing whether or not money is neutral in this New Classical model and why.
use the "Lucas Island Model" to provide an explanation as to why money is leading and pro-cyclical according to the New Classical Economists. Be sure to include a completely labeled AS/AD diagram and an explanation of what we mean exactly by a Lucas Aggregate supply curve (along with the intuition underlying it). Finish your essay by discussing whether or not money is neutral in this New Classical model and why.
b) use the "Lucas Island Model" to provide an explanation as to why money is leading and pro-cyclical according to the New Classical Economists. Be sure to include a completely labeled AS/AD diagram and an explanation of what we mean exactly by a Lucas Aggregate supply curve (along with the intuition underlying it). Finish your essay by discussing whether or not money is neutral in this New Classical model and why.
ANSWER I WROTE
The Lucas Island Model retains the assumption of rapid market clearing despite being based on incomplete information. The Lucas Island Model makes the same assumption as the traditional model that the money supply will rise before prices start to rise. Take a person, let's say a tailor. After observing the fabric market for some time, the tailor detects a rise in the cost of cloth. He believes that the relative price of cloth has increased because he is unaware of what has occurred to the prices of all other commodities, which is what we refer to as price surprise.Given the high relative cost of cloth, the tailor puts in more effort, increases his demand for money, and creates more goods. The business cycle nonetheless occurs because people in other industries act similarly. If future prices are anticipated to rise above current prices, actual output will likely exceed the threshold of full employment. The economy is still on the LRAS curve even if a rise in the money supply is precisely anticipated because both AD and SRAS would move upward. Finally, the rise in the money supply causes a rise in the price level while the output remains the same. The Lucas model could preserve the notion of markets-clearing while also explaining pro-cyclical and leading money.
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Transcribed Image Text:below, use the "Lucas Island Model" to provide an explanation
gand pro-cyclical according to the New Classical Economists.
etely labeled AS/AD diagram and an explanation of what we
ggregate supply curve (along with the intuition underlying it).
sing whether or not money is neutral in this New Classical
ains the assumption of rapid market clearing despite being based on
= Lucas Island Model makes the same assumption as the traditional
y will rise before prices start to rise. Take a person, let's say & tailor.
arket for some time, the tailor detects a rise in the cost of cloth. He
ce of cloth has increased because he is unaware of what has occurred to
odities, which is what we refer to as price surprise. Given the high
or puts in more effort, increases his demand for money, and creates
cle nonetheless occurs because people in other industries act similarly.
ed to rise above current prices, actual output will likely exceed the
t. The economy is still on the LRAS curve even if a rise in the money
ed because both AD and SRAS would move upward. Finally, the rise
a rise in the price level while the output remains the same. The Lucas
ion of markets-clearing while also explaining pro-cyclical and leading
b)
A)
LRAS
-SRAS
'Ap'
-AD
LRAS
O
-SAAS
X(b) y(a)
AP
-AD
Brittany Morgan Kohler
) You started to get there, but
needed more explanation. According
to the Lucas Island "story", workers
and firms will attribute an
unexpected increase to the price (due
to the Fèd not communicating an
increase to the money stock) as a
productivity shock, and an increase
to demand. Both will optimize by
working and hiring more, thus,
output, Y, will increase. In the short
run (fooling period), money is not
neutral because it caused a change in
behavior, but once firms/workers
realize they've been fooled, they
return to their original behavior, and
thus, money is non-neutral in the long
run.
Graph is incomplete. Missing the
SRAS leftward shift to long run when
firms/workers return to their original
production behavior when they
realized they've been fooled. See
answer key. Should clear at the
original Y value
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