California State University – Sacramento Assignment #4 Answers
ECON 100A: Intermediate Macroeconomic Theory DUE DATE: Monday, July 7th
Prof. Van Gaasbeck Summer 2008
1. IS/MP/IA in the Open Economy
a) MP shifts downward & AD shifts right. Y↑, r↓, π↑, C↑, I↑, CF↑, $ depreciates.
b) If the Fed lowered interest rates by the same amount in a closed economy, then the effect on output
would be smaller. In the open economy, when the Fed lowers interest rates, this boost BOTH
investment (I) AND net exports (CF). In the closed economy, the decrease in interest rates affects only
investment. In the open economy, we have an additional channel through which monetary policy affects
spending.
c) IS shifts leftward & AD shifts leftward. The corresponding decrease inflation causes the MP curve to
shift down. Y↓, r↓, π↓, C↓, I↑, CF↑, $ depreciates.
d) Notice that in the closed economy, the tax increase reduces interest rates which boost investment –
partially offsetting the negative effects on output (Y). Here, in the open economy, the decrease in
interest rates boosts BOTH investment and net exports, further offsetting the effects on output.
2. Phillips Curve
a) In the long run, expected inflation must equal actual inflation (otherwise, producers would adjust their
prices to reflect the difference). Recall, this is the mechanism through which the economy moves from
short run to long run in the IS/MP/IA model. We can see from the Phillips curve above, that this
π
Y
r
Y
AD
1
IA
1
IS
1
MP
1
π
1
*
Y
1
*
A
A
r
1
*
Y
1
*
AD
2
π
2
*
Y'
Y
2
*Y'
MP
2
B'
B'
r
2
*
r'
B
B
MP
3
Y
2
*
π
Y
r
Y
AD
1
IA
1
IS
1
MP
1
π
1
*
Y
1
*
A
A
r
1
*
AD
2
π
2
*
Y'
B'
B'
r
2
*
r'
B
B
MP
2
IS
2
Y'
Y
2
*
Y
1
*
Y
2
*
1a) 1c)
