I. Extinction of Covid-19 in the very-short-run closed-economy IS-LM world [45 points] Suppose the infection rates and d

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I Extinction Of Covid 19 In The Very Short Run Closed Economy Is Lm World 45 Points Suppose The Infection Rates And D 1 (290.6 KiB) Viewed 16 times

I. Extinction of Covid-19 in the very-short-run closed-economy IS-LM world [45 points] Suppose the infection rates and death rates associated with Covid-19 in a closed economy have dropped drastically. As a result, there is 180-degree turn in the sentiments of both consumers and business firms ("real investors"). All of a sudden, they become optimistic about the future of the economy. 1. [15 points] Explain how such change in confidence (or expectations) would affect consumption demand (i.e., the C-curve), saving or supply of loanable funds (i.e., the S-curve), and investment demand (i.e., the I-curve) at any given initial level of income (Y) 2. Assume that the central bank uses money supply (rather than interest rate) as its policy instrument (i.e., M-policy), so that the LM curve is upward-sloping and the corresponding AD curve is downward-sloping. (a) [7 points) State whether and in which direction each of the building blocks of AD – viz., supply of loanable funds (LS), demand for loanable funds (La), money supply (m* = ), money demand (mº), as well as IS and LM — and the aggregate demand (AD) curve itself would shift in direct response to the change in consumer confidence and investor confidence (i.e., 1st-round shifts). (b) [8 points] State whether and in which direction the (very short run) equilibrium values of each of the following variables would change as a result: output (Y), real interest rate (r), nominal interest rate (R), consumption (C), saving (S), investment (I), loanable funds (L), and real balance (m) 3. (15 points) How would you revise your answers to questions (a) and (b) above if the central bank adopts interest rate as its policy instrument (i.e., R-policy), so that the LM curve is a horizontal line and the corresponding AD curve is a vertical line.