DSE 2009

[Viren]

Ques 17:
doubt: in an IS-LM framework, what is the impact of change in expected inflation?
investment or money demand

Ques 18:
when the nominal wage is rigid , the aggregate supply schedule is ______

[duck]

hi viren..

17> an increase in expectd rate of inflation results in increases in the equilibrium value of income and a decrease in the eqm value of real interest rate.. ( because LM curve will shift down due to increase in expected inflation while no impact on IS curve)

[Viren]

hi Nidhi,
Can you tell me whether there is any change in real interest rate  which will impact investment in ques 17?
also just wanted to know whether in ques 18 , the answer is a horizontal line or upward sloping?
thanks

[duck]

hi viren..

yup a change in real rate of interest shifts the IS curve .. as investemnt is inversely related to real int rate..

yaar i just know the answer of q.18.. its upward sloping..
but dont know the rationale behind it.. (but i think when nominal wage is rigid , the agg supply curve is upward sloping till certain point and then it becomes vertical)

[duck]

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[duck]

hey hi viren!

sorry for the above mistake..
no a change in real rate of interest will not shift the IS curve (if we are drawing it in real roi and income space)...

[Viren]

I feel a change in output will not impact prices as the wages are rigid so AS should be horizontal. Can you tell what is wrong in the above reasoning.

[Ayushya Kaul]

@ Duck: Slightly confused here.
Q.17) of DSE 2011 asked if the LM curve shifts when there is an increase in expected rate of inflation.
The answere is that it remains unchanged.

So how can we say that an increase in equilibrium income and decrease in interest rate has come about from an rightward shift of LM curve for Q17 in DSE 2009?

So basically, why were are considering LM curve as a function of 'i' in 2011 and a function of 'r' in 2009?

[Ayushya Kaul]

Ques 18:
when the nominal wage is rigid , the aggregate supply schedule is UPWARD SLOPING.

Could someone confirm the rationale behind this answer?

[duck]

Hi Ayushya.. :)

2011: Question is silent on whether we're plotting on (Y,r) space or (Y,i) space and we're asked to find what happens to the LM curve.
Now, we know LM is a function of nominal interest rate(i). So, will assume we're plotting on (Y,i) space. Hence, any change in expected inflation rate will have no impact on LM curve.

2009: We're asked to find what happens to the real interest rate. So, will plot in (Y,r) space. Now, an increase in expected inflation rate will have no impact on IS curve but will  shift the LM curve on the right. Hence, an increase in income level and a decrease in real interest rate.

[Do bats eat cats?]

Q 18.

My macroeconomic intuition is always incorrect, but I think that the source of confusion is the rigid nominal wage.

We are told that nominal wage is rigid. So, if prices rise, real wage declines.
When real wage declines, firms hire more labour and hence produce more output. Thus, the aggregate supply is upward sloping.

[Ayushya Kaul]

Thanks a lot duck and do Bats eat cats:D