# PROBLEM SET 6

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```					                              HOMEWORK #5

The Problem attached is due on Tuesday, November 9
(May be answered on these sheets)
This problem must be turned in before or at the beginning of class on
Tuesday, Nov. 9 because we will be going over it immediately! (I will not
accept this homework assignment after I collect it in class).
2

NAME _______________________________________
*You may answer on this sheet.
Suppose the economy is initially operating at Yn. Now suppose that private citizens
desire to hold more of their wealth as safe money assets rather than as risky bonds
(increase demand for money).
a.     What happens to the level of output (Y), the price level (P), and the interest
rate (i) in the short-run? Use the diagrams below to illustrate. Briefly explain the
rationale for any curves you shift (use back of sheet if necessary).            (10 points)

P
AS (Pe = P0 = 100)

P0= 100                           MR

Yn                      Y
i

LM (P0 = 100)

i0                          MR

IS

Yn                      Y
3

b.    Redraw your short-run equilibrium on the graphs below and also draw the
NEW medium-run equilibrium. Clearly show what happens to Y, P, and i in the NEW
medium-run compared with the original medium-run equilibrium.             (6 points)

P
AS (Pe = P0 = 100)

P0= 100                         MR

Yn                     Y
i

LM (P0 = 100)

i0                        MR

IS

Yn                     Y
4

c.     Explain HOW THE ECONOMY MOVES FROM SHORT-RUN TO MEDIUM
–RUN EQUILIBRIUM, i.e. explain THE DYNAMIC ADJUSTMENT PROCESS IN THIS
PARTICULAR SITUATION (Hint: think about the interplay of the actual and expected
price level as the economy moves through the adjustment process).      (4 points)

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