Answer to Question #219704 in Macroeconomics for Romeo

Question

1.   The IS-LM model is a simplification of the interrelationship between selected economic variables. The model consists of a number of endogenous variables (those variables whose values are determined inside the model) and a number of exogenous variables (those variables whose values are determined outside the model). The labour markets mostly consider the relationships between prices, expected prices, unemployment among other macroeconomic variables.

(a)    Explain endogenous and exogenous variables in the IS-LM model as well as the labour markets, derive the AD-AS model.

(b)   In the labour market, explain how the rate of unemployment is related to the bargaining power and nominal wages.

(c)    As a policy consultant, use the AD-AS framework to explain how the health of the South African economy can be improved given you diagnosis in question 1.

Note: Please use diagrams to aid your explanation.

Answer 1

a) The 3 exogenous variables within IS-LM model include investment, consumption and liquidity. Based on the theory, liquidity depends on money supply's velocity and size. Consumption and investment levels are based on marginal decisions as per the individual actors.

Endogenous variable tends to be a variable which is determined or changed through its linking factors with the rest of the variables within statistical model. Similarly, endogenous variable correlates with other aspects within the area.

b)

When rate of unemployment rises, it tends to be more hard for people finding employment at some companies. Therefore, the bargaining power of workers will fall. The nominal wage falls when the bargaining power falls.