ECON 101 Tutorial: Week 18
Shane Murphy
s.murphy5@lancaster.ac.uk
Office Hours: Monday 3:00-4:00 – LUMS C85
Outline
• Roll Call
• Problems
• Game
Chapter 30: Problem 3
Plot unemployment and inflation figures over the
last 30 years. Is the trend stationary, nonstationary,
or indeterminate?
Chapter 30: Problem 3
Plot unemployment and inflation figures over the
last 30 years. Is the trend stationary, nonstationary,
or indeterminate?
Chapter 30: Problem 5
Explain whether the comovements are procyclical or
countercyclical:
a) GDP and inflation
b) GDP and employment
c) GDP and unemployment
d) GDP and the money supply (M1)
When a variable is above trend when GDP is above trend the
variable is said to be procyclical. If a variable is below trend
when GDP is above trend the variable is described as
countercyclical. In general then the results should be:
a) Procyclical
b) Procyclical
c) Countercyclical
d) Tends to be procyclical
Chapter 30: Problem 8
There is a fall in the price level which workers do not
anticipate. Explain what effect such a scenario will
have on output.
The new classical model is based around the concept
of anticipated and unanticipated price changes.
• If workers do not have perfect information they
may not be aware of the impact of the fall in price
level, workers continue to supply the same
amount of labour,
– So real wages do rise, firms demand less workers and
output will fall.
Chapter 30: Problem 10
Which business cycle model do you find most
compelling and why?
Chapter 31: Problem 3
Suppose economists observe that an increase in
government spending of €10 billion raises the total
demand for goods and services by €30 billion.
a) Ignoring crowding out, what would the MPC be?
b) Would crowding out raise or lower the estimate?
Why?
Crowding out would lower the estimate of MPC because the
multiplier effect would be offset by higher interest rates
Chapter 31: Problem 4
Suppose the government reduces taxes by €2 billion, MPC is 0.75,
and there is no crowding out.
a) What is the initial effect of the tax reduction on AD?
The initial effect is to increase aggregate demand by €1.5 billion (€2
billion x 0.75).
b) What additional effects follow this initial effect? What is the total
effect of the tax cut on AD?
There will be additional induced changes in expenditure, i.e. a multiplier
effect. The total effect is given by:
€1.5 billion x k where k is the multiplier.
The value of the multiplier is 1/(1-MPC), and MPC in this case is 0.75, so
that k = 4.
Therefore the total effect of the tax cut is to increase aggregate demand
by €6 billion.
c) How does the total effect of this €2 billion tax cut compare to the
total effect of a €2 billion increase in government purchases? Why?
The total effect of a €2 billion increase in government purchases will be
to increase aggregate demand by €8 billion.
Chapter 31: Problem 6
What do the IS and LM curves show?
The IS curve shows all combinations of interest rate
and national income at which the goods market is in
equilibrium. The LM curve shows all combinations of
interest rate and national income at which the
money market is in equilibrium.
Chapter 31: Problem 8
Use IS-LM to explain:
a) The government institutes significant cuts in public
expenditure.
Significant cuts in government spending will shift the IS
curve to the left. The extent of the fall in interest rates
and national income that result will depend on the slope
of the LM curve, and this depends on how responsive is
the demand for money to changes in interest rates.
Assuming that the LM curve has a positive slope and is
not vertical, there will be some reduction in interest
rates and the effect of reduced government spending on
economic activity will be less than would otherwise
have been the case.
Chapter 31: Problem 8
Use IS-LM to explain:
b) The Central bank institutes an asset purchasing
facility which expands money supply.
Expanding the money supply will shift the LM curve
to the right. The extent of the fall in interest rates
and the rise in national income that result will
depend on the slope of the IS curve, and this
depends on how responsive is consumption and
investment expenditure to changes in interest rates.
Chapter 31: Problem 8
Use IS-LM to explain:
c) The central bank fears that inflationary pressures are
rising and increases interest rates.
If the central bank wishes to raise interest rates it must
engage in open market operations to sell bonds and so
reduce the money supply. This action is reflected in a
leftward movement of the LM curve. This size of the
reduction in money supply needed to raise interest rates
to a particular level will depend on the slope of the IS
curve – the flatter the IS curve the greater the shift the
LM curve that will be needed, and the greater will be
the associated reduction in national income.
Chapter 31: Problem 8
Use IS-LM to explain:
d) The government increases taxation to try and reduce a large
budget deficit.
An increase in taxation will shift the IS curve to the left. The
effect will thus be similar to that described in answer to
question 10a - will shift the IS curve to the left. The extent of
the fall in interest rates and national income that result will
depend on the slope of the LM curve, and this depends on
how responsive is the demand for money to changes in
interest rates. Assuming that the LM curve has a positive slope
and is not vertical, there will be some reduction in interest
rates and the effect of reduced government spending on
economic activity will be less than would otherwise have been
the case.
Chapter 31: Problem 10
Do you think that Keynes’ ideas still have some
relevance today?
Exam Notes
• 4 questions
• Memorize key terms and definitions
• Macroeconomics isn’t always as intuitive as
microeconomics so make sure you study
16
Game
• http://sffed-education.org/chairman/
17