Question

2-) The Government observes a significant amount of unemployment in the economy. Some argue that the government should stimulate the economy in order to decrease the unemployment level using monetary policy.

a) Using the theory of liquidity preference, show the effects of expansionary monetary policy. What will happen to the interest rate? What will happen to the aggregate demand as a result? You must explain why we observe this relationship.

b) Draw the new short-run equilibrium of the economy. What happened to the price level, output and the unemployment level in the new short-run equilibrium?

c) How will the economy adjust in the long-run? Explain the transition and show it on a graph. What will happen to the price level, output and unemployment?

d) Show how the same economy will adjust in the short-run and the long-run using a Phillips curve this time. Use the same labels you used for the initial, the short-run and the long-run equilibrium that you used in part c).

e) Would you advise the government to undertake this policy considering your answers to part c) and

d)? Why? What will be happening to the policy options in the long-run? Explain by talking about the trade-off options between unemployment and inflation.

Answer 1

   ANSWER.

A. An expansionary monetary policy will move the flexibly of cash (MS) to one side. Subsequently the pace of intrigue will descend. It urges the financial specialists to expand their venture which makes more pay with the assistance of multiplier. Creation, work and yield increment in the economy. So utilization or total interest in the economy will increment. We can comprehend that an increment in the cash gracefully through expansionary monetary policy will at last lead to an expansion in the total interest. There two are emphatically related.

B. An expansion in the total interest move to one side( AD to AD1) and new balance point is built up at B where cost is P1 and yield is Y1( both are expanding). The joblessness will fall in the short run. This is shown in the underneath figure.

C. Assume an expansion in the cost level elevates firms to create more accordingly AS movements to one side and yield increment Y2 and value goes to its typical level. Over the long haul so as to keep up harmony AS movements to one side ( in view of the fall in the value level). With the goal that value rises further and yield cones to its unique level over the long haul. The joblessness will increment now contrasted with starting levels. This is shown in the above figure.

D. In the short run Philips bend, at first joblessness falls because of monetary development. Thus individuals flexibly more work since they are impermanent cash hallucination ( individuals have encountered value strength at A). at the point when they understood it go to its typical position. This procedure proceeds. By joining A, B, and C, we will get since a long time ago run philips bend. This is shown in the beneath chart

E. The administration policy will give short run benefits as it were. There is no lasting exchange off among expansion and joblessness in the desire expanded Phillips bend. Here the legislature would endeavor to decrease joblessness by monetary extension which will diminish joblessness in the short run which raise the value level. Be that as it may, over the long haul joblessness go to its common level butOne the value rises (swelling) we can't pull down the expansion in its unique level. So government ought to embrace a policy which have just an impermanent effects in the economy. The explanation is that over the long haul there is no exchange off among expansion and joblessness.

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