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# Tutorial_Solution_(Ch_11).doc

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University of Toronto Scarborough

Economics for Management Studies

MGEB06H3

Jack Parkinson

Summer

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MGEB06 Tutorial Questions (Chapter 11) Answer Key
Question 1
• When people realize that they must save a larger portion of their income for
retirement, saving ↑ and consumption ↓:
⇒ C ↓ to C ⇒ E ↓ ⇒ IS curve shifts down and to the left to IS(C ). 1
• Introduction of new technology leads to a reduction in the demand for money:
d d
⇒ M = L(r, Y) ↓ to M = L (r, Y) ⇒ LM curve shifts down and to the
P 0 P 1
d
right to LM( (M /P) 1.
• Since the magnitudes of shifts of both IS and LM curves are unknown, points B, C,
and D are potential short-run equilibrium:
⇒ If IS shifts more than LM, point B is the equilibrium: Y ↓, r ↓
⇒ If IS shifts less than LM, point C is the equilibrium: Y ↑, r ↓
⇒ If shift in IS = shift in LM, point D is the equilibrium: no change in Y, r ↓
• Conclusion: r falls but the overall effect on Y is ambiguous.
r LM( (M /P) ) LM( (M /P) )
0 1
A
C
D
B
IS(C )
IS(C ) IS(C ) IS(C )1 Y
MGEB06 Tutorial Question (Chapter 11) Answer Key 1 Question 2
The economy is currently at point A such that Y > Y . Now, policy makers want to
FE
bring Y back to Y .FE
Case 1: Contractionary fiscal policy, G ↓:
• G ↓ ⇒ planned expenditure, E, ↓ ⇒ IS shifts to the left to IS(G ).1
• Point B is the equilibrium:
Y ↓ back to Y FE
1
r ↓ to r
I ↑ because when r ↓, cost of borrowing ↓ and I ↑.
Case 2: Contractionary monetary policy, M ↓: S
S S
• M ↓ ⇒ LM shifts to the left to LM( (M /P) ). 1
• Point C is the equilibrium:
Y ↓ back to Y FE
r ↑ to r
I ↓ because when r ↑, cost of borrowing ↑ and I ↓.
Conclusion: Policy makers should pursue contractionary fiscal policy because a fall in
G leads to a fall in r and an increase in I.
S S
r LM( (M /P) ) 1 LM( (M /P) )0
2 C
r

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