Econ 302 Exercise Set 6

SIXTH TAKE-HOME EXERCISE SET [14 Points Total]       L. Tesfatsion
DUE DATE:  Tuesday, April 30, 9:30 A.M.         Econ 302/Spring 96
**PLEASE NOTE: As always, no late assignments will be accepted.

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EXERCISE 6.1  [6 Points Total].  This exercise extends the
previously assigned "balanced budget" exercise 3.4 on the Third
Exercise Set.  Consider an economy described by the following six
relations, where D denotes an exogenously set target level for
the government budget deficit:
     (1) Y = C + I + G + NE
     (2) C = a + b[1-t]Y
     (3) I = e - dR
     (4) NE = g - mY - nR
     (5) M/P = kY - hR
     (6) G - tY = D
Period T endogenous variables:  Y, C, I, NE, R, G
Exogenous variables (positive): a,b,t,e,d,g,m,n,M,P,k,h,D,
                                with t,b less than 1

Part A: Define what is meant by an IS curve for the economy
described by relations (1) thru (6).  Derive an algebraic
expression for the IS curve for this economy and illustrate this
curve graphically.  Determine whether or not an increase in D
affects the IS curve, and illustrate any effects graphically.

Part B: Define what is meant by an LM curve for the economy
described by relations (1) thru (6).  Derive an algebraic
expression for the LM curve for this economy and illustrate this
curve graphically.  Determine whether or not an increase in D
affects the LM curve, and illustrate any effects graphically.

Part C:  Using Parts A and B, graphically determine how an
increase in D affects the IS-LM equilibrium values Y^o and R^o
for GDP Y and the real interest rate R.  Provide an economic
interpretation for your findings.  In particular, do your
findings suggest that an increase in D (i.e., an increase in the
size of the government budget deficit) has negative short-run
implications?  negative long-run implications?  Explain
carefully.

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EXERCISE 6.2  [4 Points Total]. Hall and Taylor, Chapter 9,
ANALYTICAL exercise 9, page 262. #Be sure to justify your
assertions and label all graphs carefully.#

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EXERCISE 6.3 [4 Points Total]. Hall and Taylor, Chapter 9,
MACROSOLVE exercise 5, page 264. #Be sure to justify your
assertions and include with your answer any MacroSolve data
referred to in your answer#.
    NOTE: The "price shock" referred to in part b is a term Z(T)
appended to the usual expectations augmented Phillips curve that
is treated as an exogenous variable (a disturbance to the economy
from "outside"):
     INF(T,T+1) = INF^e(T,T+1)  + [Y(T)-Y*(T)]/Y*(T)  +   Z(T) .
The effect of Z(T) is to cause a sudden change in P(T+1) not due
to either inflationary expectations or GDP gap pressures.

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