Macroeconomics homework Short answer 1Use the sticky wage th

Macroeconomics homework Short answer

1.Use the sticky wage theory of aggregate supply to explain what will happen to output and the price level in the long run. What role does expected price level play in the adjustment?

1.a Describe how an increase in the money supply affects aggregate demand.

1.b Why in the short run does the interest rate adjust to balance the supply and demand for money.

Solution

1. In the short run price and output bears one to one correspondence for wage sticky model. Expectation play an important role in the long-run. It may give misconception initially but in the long run average of foresight of aggregate consumer will tend to its actual.

1.a. Rise in money supply will raise up the speculative demand for money. People will like to purchase bonds and financial assets. Hence, rate of interest will go down as asset price, viz. bond price go up. Fall in rate of interest raises investment and via multiplier process output rises.

1. b. Equilibrium occurs when money demand=money supply. Money demand has two components; i. transaction demand that depends on output and ii. speculative demand that depends on rate of interest. Now, our ultimate motive is to adjust output. Hence, rate of interest is the sole exogenous parameter in this regard that makes people to decide how to distribute wealth among money and bonds.