Quiz on Equilibrium Interest Rate in Money Market

a. What would be the effect of such a policy on equilibrium interest rate in the money market? Explain why the equilibrium interest rate changes the way it does. Provide a graphical illustration using the appropriate diagram(s). (10 points)

b. Discuss the effects of the policy on equilibrium output and interest rate in the economy using the ISLM-ADAS model in the short run. Explain which market (or markets) is (or are) affected and which curves shift. Illustrate your answer with the appropriate diagrams. (10 points).

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c. Now discuss the effects in the medium run. You do not need to draw new diagrams; but you should refer to the diagrams in part b above and state which curves shift and in which direction they shift, and what happens to output and the interest rate in the medium-run equilibrium. A branch of the economics profession has argued that money is “neutral”. Does your analysis support this claim? Explain. (10 points)

Question II.3 (30 points) 2

a. Describe the factors that influence wage setting. Write down the equation that represents wage setting, describe the effect of each factor in the equation/function, and draw the corresponding diagram. Clearly state the assumptions behind your analysis. (10 points)

b. Briefly describe the “efficiency wage” theory. Explain why a firm would want to pay a wage that is higher than the market wage rate. What theories can motivate such a practice? (10 points)

c. The conventional (classical) labor market theory suggests that i) the wage rate adjusts smoothly so that labor supply equals labor demand; ii) wages are set competitively across markets; iii) there is no ‘involuntary’ unemployment (anyone who wishes to work can work). Does this reflect the reality in real economies? If not, explain why. (10 points)

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