Question

SA Question 3: 2-period model
Consider the closed-economy 2-period competitive equilibrium discussed in class.
PART 3a (2 pts): Assume the representative firm has constant-returns-to-scalé technology and that first period capital is
exogenously fixed. Explain why the Labor Demand curve is downwards sloping. (That is, explain why the aggregate
labor demand decreases when real wages increase.) Your explanation can be algebraic or graphical
Now make the following additional assumptions about our economy:
For the consumer the income effect is outweighed by the substitution effect. so that an increase in real wage is associated
with an increase in the aggregate labor supply.
The economy is a small open economy. It interacts with a much larger global credit market. Thus the real interest rate is
exogenously fixed at the global interest rate ro.
Money is neutral, the domestic monetary authority has flexible exchange rates, and uses monetary policy to keep the
domestic price level stable.
PART 3b (2 pts): Draw and clearly label graphs illustrating equilibrium in this economy. You will need a graph for
the first-period labor market, a graph for the first period output market, and a graph for the first-period money market.
showing the relationship between Mand P.
PART 3c (3 pts): On a copy of your graphs, illustrate the effects of a decrease in the world interest rate.
PART 3d (3 pts): On a copy of your graphs, illustrate the effects of an decrease in First-Period Total Factor Productivity.
EXTRA CREDIT (2 pts): Now suppose instead that the monetary authority enacts a fixed exchange rate. Explain/show
how this changes your answers to parts c and d above,​

Answer 1

Answer:

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