Question

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Consider the AS-AD model discussed in the course. Assume, initially, that the real interest rate only affects domestic investment. a. Write down the expressions for the AS and AD curves and interpret the expressions. What must be true of the model parameters and variables in the long-run equilibrium, i.e. in the steady state? (6 points) b. Analyse the effects of a supply shock that causes a decrease in inflation, preferably using a diagram. Assume that the shock lasts for one period and then assumes the value zero. Describe the mechanisms that brings the economy back to long-run equilibrium. What happens to aggregate demand? (5 points) C. Now assume that net exports, NXĘ, as a fraction of potential GDP, 7t, are determined by the following equation: Nxt = anx – Bux(r+ - r;), where re is the real interest rate and * denotes foreign. Explain the intuition behind this expression. (4 points) d. Derive the IS-curve when net exports are determined as in question c above. (5 points)

Answer 1

a) The AD-AS is a model is a way of illustrating national income determination and changes in the price level. We can use this to illustrate phases of the business cycle and how different events can lead to changes in two of our key macroeconomic indicators: real GDP and inflation.n macroeconomics, the focus is on the demand and supply of all goods and services produced by an economy. Accordingly, the demand for all individual goods and services is also combined and referred to as aggregate demand.

b) Stock prices are a function of supply and demand, although other influences such as earnings and the economymight affect the desirability of owning or selling a particular stock. If a company reports surprisingly low earnings, demand for its stock might fade, and as the price drops, the balance between buyers and sellers is changed. Buyers will begin demanding discounts off the existing price, and many motivated sellers will accommodate them to get rid of the stocks. When there are more sellers than there are buyers, this creates more supply than demand, so the price begins to fall. If demand for a stock exceeds the supply, its price will rise, but it will only increase to a point where buyers suspect that demand is waning. At that point, holders of the stock will likely begin selling. Some might have ridden the price up and believe a reversal is coming, so they sell their shares and take their profits while they are still ahead.

c) NXT/YT=anx-bnx(rt-nt) and this is the main criteria which is followed when the stock increases and also the demand increased based on the price of the products Though GDP is usually calculated on an annual basis, it can be calculated on a quarterly basis as well. In the United States, for example, the government releases an annualized GDP estimate for each quarter and also for an entire year. Most of the individual data sets will also be given in real terms, meaning that the data is adjusted for price changes, and is, therefore, net of inflation.

d) .IS curve of the open economy also includes net exports  as a component of aggregate demand for goods. The real exchange rate of the national currency, which determines the prices of exports and imports and thereby determine net exports also affects the open economy IS curve.