Macro Essay Example | Topics and Well Written Essays - 1500 words

Macro - Essay Example This can be thought of as a result of the rise in price levels. However, because of the price rise, the SRAS curve shifts out to SRAS2. As a result the short-run equilibrium in period 2 is E2, Output falls to Y2 and the price level shoots down to P2. Hereon, the aggregate demand curve remains stationary, and the SRAS gradually climbs along the AD curve back to the initial equilibrium level. The price climbs up back to P0 and the output level converges to its long run level over the long run. Thus, in the long run there are no effects of the positive demand shock since it is temporary. However, there are short-and medium run effects. 2. To answer this question it is important to understand what the role of MPC is in the construction of the IS curve. In the diagram above, we show how an increase in investment affects the goods market equilibrium. Suppose initially the interest rate was fixed at r0 and the investment expenditure was I0. The Effective demand was E0 = C+I0+G. As shown in the above part of the diagram, the effective demand intersects the 45 degree line at output level Y*. Thus, the combination (r0,Y*) ensures equilibrium in the goods market. It is thus a point on the IS curve. Now suppose the interest rate falls to r1. As a result investment rises to I1. So, there is an increase in effective demand as well. Consequentially, Y** is the new equilibrium point. Therefore (r1,Y**) is another equilibrium combination of interest and real income. Joining these we get the IS curve in the lower half of diagram 2. The crucial point to note here is that the slope of the IS curve depends crucially on the slope of the effective demand curve, which is the MPC. Evidently if the Effective demand curve was steeper implying a higher MPC, then the increase in equilibrium income would have been smaller. Thus, we understand that higher the MPC, steeper will be the IS curve. The increase in equilibrium income following an autonomous increase in investment follows a multipl ier mechanism. The value of the multiplier is equal to: . Therefore if the mpc = .75, multiplier is equal to 4 and if mpc = 0.25, the multiplier is equal to 1.33. Therefore, the increase in the income will be equal to 4*60 =$ 240 million in the first case while it will be only $79.8 million in the latter case. The reason for a smaller increase in income when the mpc is smaller lies in the definition of the mpc. It stands for the additional spending on consumption from each additional dollar earned. The higher this value, the higher will be the increase in effective demand following every increase in income. The propagation will be greater, greater the mpc. 3. Obama selling hard on economic stimulus plan AGENCIES,  Jan 25, 2009, 07.49pm IST WASHINGTON: President Barack Obama relentlessly pressed his sales pitch for $825 billion in government spending to halt the US economic slide, dispatching his vice president and top economic adviser for appearances on Sunday television interview programs. Vice President Joe Biden and Larry Summers, the economic chieftain, will be emphasising the message outlined by Obama in his first Saturday radio and Internet address from the White House. The new president touted the benefits of the huge spending program, telling Americans it would produce better schools, lower electricity bills and