The following equations characterize a country’s closed economy.
Production function: Y = A·K·N – N2/2
Marginal product of labor: MPN = A·K – N.
where the initial values of A = 9 and K = 9.
The initial labor supply curve is given as: NS = 31 + 9w.
a) (5 points) Find the equilibrium levels of the real wage, employment and output (show work).
Draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph. Be sure to label everything including these initial equilibrium points as point A.
(10 points for correct and completely labeled diagrams)
Initial conditions in the goods market
Cd = 1000 + .50(Y-T) – 500r
Id = 610 – 500r
G = 100
T= 100
Initial conditions in the money market
Md/P = 212 + .5Y - 1000 (r + πe)
where M = 2400 and πe = 0.02 (2%)
b) (5 points) Given these initial conditions in the goods market, solve for an expression of the IS curve (r in terms of Y).
c) (5 points) Given the initial output, as in part a), what is the goods market clearing interest rate?
d) (5 points) Given the initial output as in part a) and the goods market clearing interest rate as in part c), what is the general equilibrium price level?
e) (5 points) Please solve for an expression for the LM curve (r in terms of Y).
Now draw four separate diagrams: (40 points total) Top left: a desired savings equals desired investment (Sd = Id ), Top right: a FE - IS – LM diagram, Bottom left: a money market diagram, Bottom right: An AD - AS diagram, locating this initial equilibrium point as point A. BE SURE to LABEL all diagrams completely (10 points for each correctly drawn and labeled diagram…each diagram will have two different equilibrium points A and B)
