Download ECON 3560/5040 Homework #6 (Answers)

ECON 3560/5040
Homework #6 (Answers)
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Part A (6 points) Fill-in Questions
(1) [2 points] When the Fed changes the money supply to offset an adverse supply or demand
shock and to keep output and employment at their natural levels, this is an example of
Stabilization Policy
(2) [2 points] The Aggregate Demand curve depicts a relationship between the quantity of output
demanded and the aggregate price level
(3) [2 points] The IS curve shows the relationship between the interest rate and the level of
income at which planned expenditure is equal to actual expenditure
Part B (14 points)
(1) [9 points] Short Run Economic Fluctuations
Assume that the long-run aggregate supply curve is vertical at Y = 3, 000 while the short-run
aggregate supply curve is horizontal at P = 1.0. The aggregate demand curve is Y = 3(M/P )
and M = 1, 000
(a) [3 points] If the economy is initially in long-run equilibrium, what are the values of P
and Y ?
P = 1, Y = 3000
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(b) [3 points] Now suppose a supply shock moves the short-run aggregate supply curve to
P = 1.5. What are the new short-run P and Y ?
P = 1.5, Y = 2000
(c) [3 points] If the aggregate demand curve and long-run aggregate supply curve are unchanged, what are the long-run equilibrium P and Y after the supply shock?
P = 1, Y = 3000
(2) [5 points] Aggregate Demand and Aggregate Supply Model
Suppose that droughts in California substantially reduce food production in the U.S. Use
the aggregate demand-aggregate supply model to illustrate graphically the short-run AND
long-run impact of this adverse supply shock on output(Y ) and prices(P )
In the short run, output decreases while the price level rises. In the long run, prices falls and
output returns to the full-employed level
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Part C (10 points) Working with Macroeconomic Data
It has been argued that the stock market predicts recessions. Using quarterly data since 1961,
plot the “real” value of the stock market index (the S&P 500 index in the last month of the quarter
divided by a price index). Note that data on the S&P 500 index may be found at finance.yahoo.com
or home page of Robert Shiller, econ.yale.edu/˜shiller. Draw in the business cycle peaks and
troughs. Do you find the stock market to be a good economic forecaster? Business cycle reference
dates are available from the NBER (National Bureau of Economic Analysis) Website, www.nber.org
See attached figure
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Figure 1: Real S&P 500 index, 1961:Q1-2008:Q4
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