Question

Assume that prices and wages adjust rapidly so that the markets for labor, goods, and assets are always in equilibrium. What are the effects of each of the following on output, the real interest rate, and the current price level?

1. A temporary increase in government purchases.
2. A reduction in expected inflation.
3. A temporary increase in labor supply.
4. An increase in the interest rate paid on money.

Answer 1

Answer:

a. A temporary increase in government purchases :

A temporary increase in government purchases would decrease savings, which would lead to the government implementing higher taxes in other to math prices and wages.

This would lead for output to stay the same, Real Interest to increase and current price level to increase as well.

b. A reduction in expected inflation.

A reduction in expected inflation would lead to an increase in real money demand because people do not expect inflation to increase for a while. Therefore more demand creates a decrease in the price level. Everything else stays the same. This would lead for output to stay the same, Real Interest to stay the same and current price level to decrease.

C. A temporary increase in labor supply.

A temporary increase in labor supply would mean more people have jobs and therefore more people can save. If more people save the interest rates are prone to decrease therefore money demand will increase. . This would lead for output to increase, Real Interest to decline and current price level to decrease.

d. An increase in the interest rate paid on money.: .

An increase in the interest rate paid on money will cause a higher demand of money. With the same nominal money supply and a higher demand of money the price would decline but everything else stays constant. This would lead for output stay the same, Real Interest to stay the same and current price level to decrease.