Question

Find the effects of each of the following on the general equilibrium values of the real wage, employment, output, the real interest rate, consumption, investment, and the price level. IllUSTRATE YOUR ANSWERS WITH APPROPRIATE GRAPHS (IS-LM-FE).
a) The expected rate of inflation decreases.
b) The future marginal product of capital decreases. (Assume that there is no effect on current labor supply.)

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Answer 1

decrea a) Expected rate of inflation Inflation Rate (A) X tre NO rate Unemployment Unemployment rate decreases le level of employment in the econo my increases. From fisher's equation, i= ert; when inflation decreases the real interest rate increases. The price The price e lenel decreases out as inflation rate decreases: Rise in interest rate will reduce consumption innestment and

also reduce investment expenditure as cost of borrowing increases people start barning more! Rise in interest rate will lead to an inflow of foreign exchange as a result there will be an appreciation in domestic currency pexchange rate Forex Market. Foreign exchange

(6) MPx decreases and MP remains same. 1 As MPx decreases and MP remains same. The demand for labour would increase as labour is substituted for capital. A wo Wo labour Klarits go D Employment rate increases As unemployment rate decreases, the inflation rate decreases. The real interest rate increases The price level decreases. Rise in interest rate will reduce consumption innestment and