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University of Toronto Scarborough
Economics for Management Studies
Jack Parkinson

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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