Answer to Question #156160 in Macroeconomics for Jameel

Question

Consider the following model of an extended classical economy: 1. Y =(12350/7)+(10/7)(M/P) 2. Y =+100[P-p] 3. Y 4. Y =6000 5. U = 0.05 6. M = 88950 7. * = 0 (a) What do equations 1, 2 and 3 represent in the above model? Briefly explain. (b) Suppose that p = 29.15. What are the short run equilibrium values of P, Y and U? (c) Is the economy in long run equilibrium? If not, why? Explain this adjustment using labour market analysis. What are the long run equilibrium value of P and p? (d) Find out the values of cyclical unemployment and unanticipated inflation. Does the Phillip curve relation hold? (e) Draw diagram(s) indicating all points. (t) Suppose that the central bank decides to take advantage of the low price expectations and announces a contractionary monetary policy (so that actual price also adjusts in line with expectations) before any labour market adjustment has taken place. By what percentage should the central bank change the money supply? What will be the new equilibrium?

Answer 1

a)

equation 1 = aggregate demand

equation 2 = short run aggregate supply

equation 3 = income function

b)

$AD=SRAS$

$12350/7+(10/7)(M/P) =Y+100(P-p)$

p=29.15

Y=6000

M=88950

$12350/7+(10/7)(88950/P)=6000+100P-29.15$

$889500=700P^2+9244.998P$

$700P^2+9244.998P-889500=0$

P=29.64

$Y=6000+100(29.64-29.15)$

$Y=6049$

$[(Y-y)/y]=2[U-u]$

$[(6049-6000)/6000]=[u-0.05]$

$U=0.046$

c)

the economy is in long run

in the long run there will be labor market adjustment to meet the excess demand sending the prices back to equilibrium

long run equilibrium prices of P and p

$6000=12350/7+(10/7)(88950/P)$

$P=210$

$6000=100[210-p]$

$p=150$

d)

Phillip curve relationship holds

e)