St.

Marry University
Faculty of Business
Department of Management
Macroeconomic Group assignment
Section B
Group members ID

1. Bethelhem Legesse………………………………………….RMD/1299/2014
2. Helina T/ Hawariat…………………………………………..RMD/0674/2014
3. Hermela Azanaw …………………………………………....RMD/0675/2014
4. Hiwot Solomon………………………………………………..RMD/0678/2014
5. Merhawit Mezgebu………………………………………….RMD/0683/2014
6. Nathnael Seyfu…………………………………………………RMD/0688/2014
7. Melat Goitom ………………………………………………….RMD/1304/2014
8. Rediet Temesgen …………………………………………….RMD/1306/2014

Submitted to: Instructor Nefisa M

Submission date: Jan 2024

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 The four model of aggregate supply curve
The aggregate supply curve represents the relationship between the overall level of
prices and the quantity of goods and services that firms are willing to produce. There
are four main models of aggregate supply curve: the sticky wage model, the
imperfect model, the worker misperception model, and the sticky price model.

1. Sticky Wage Model

According to this model, wages are "sticky" or slow to adjust in response to changes in the
overall price level. When the price level rises, firms' production costs increase, but they are
unable to lower wages immediately. As a result, firms reduce their output, leading to a decrease
in the aggregate supply. Conversely, when the price level falls, firms' production costs
decrease, but wages do not adjust downward quickly, leading to an increase in the aggregate
supply.

2. Imperfect Model
The imperfect model of aggregate supply suggests that firms have imperfect information about
changes in the overall price level. In this model, firms adjust their prices based on their
expectations of future price changes rather than actual changes. If firms expect prices to rise,
they increase their output to meet the anticipated demand, leading to an increase in aggregate
supply. Conversely, if firms expect prices to fall, they reduce their output, leading to a decrease
in aggregate supply.

3. Worker Misperception Model

According to the worker misperception model, workers may have incorrect perceptions about
changes in the overall price level. When the price level rises, workers may mistakenly believe
that their real wages have increased. As a result, they may choose to work more hours, leading
to an increase in the aggregate supply. Conversely, when the price level falls, workers may
mistakenly believe that their real wages have decreased and reduce their work hours, leading to
a decrease in the aggregate supply.

4. Sticky Price Model

The sticky price model assumes that prices are slow to adjust in response to changes in the
overall price level. In this model, firms are unable to change their prices immediately due to
factors such as menu costs or long-term contracts. When the price level rises, firms with sticky
prices find that their relative prices have fallen, leading to a decrease in the aggregate supply.
Conversely, when the price level falls, firms with sticky prices find that their relative prices have
increased, leading to an increase in the aggregate supply.

These models provide insights into the various factors that can influence the behavior of firms
and workers in response to changes in the overall price level, ultimately shaping the aggregate
supply curve. It's important to note that in reality, a combination of these factors may be at play,
and the actual behavior of firms and workers can be more complex than what these models
suggest.

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 why the aggregate demand curve slopes downward.
The aggregate demand (AD) curve slopes downward due to three main reasons: the
wealth effect, the interest rate effect, and the exchange rate effect.

1. Wealth Effect
When the price level decreases, the real value of money increases. This means that consumers
feel wealthier and are able to afford more goods and services with their existing wealth. As a
result, they increase their spending, leading to a higher quantity of goods and services
demanded. Conversely, when the price level increases, the real value of money decreases,
making consumers feel less wealthy and reducing their purchasing power, which leads to lower
spending and a decrease in the quantity of goods and services demanded.

2. Interest Rate Effect

A decrease in the price level increases the purchasing power of money. As a result, people
need less money to make purchases, leading to a decrease in the demand for money. This
reduction in demand for money leads to lower interest rates, which stimulates investment and
consumption. Conversely, an increase in the price level reduces the purchasing power of
money, increasing the demand for money and leading to higher interest rates, which in turn
discourages investment and consumption.

3. Exchange Rate Effect

A decrease in the price level makes domestic goods relatively cheaper compared to foreign
goods. This leads to an increase in exports and a decrease in imports, boosting net exports and
increasing aggregate demand. Conversely, an increase in the price level makes domestic goods
relatively more expensive compared to foreign goods, leading to a decrease in exports and an
increase in imports, reducing net exports and decreasing aggregate demand.

These three effects collectively contribute to the downward slope of the aggregate demand
curve, illustrating the inverse relationship between the price level and the quantity of goods and
services demanded in an economy.

Work out
1)In the Keynesian cross model, assume that the consumption function is given by C = 200 +
0.75 (Y − T). Planned investment is 100; government purchases and taxes are both 100.

A. derive the is function

To derive the IS (Investment-Saving) function in the Keynesian cross model, we need to equate
planned investment and total saving.

In the model, total saving (S) is given by the difference between disposable income (Y - T) and
consumption ©.

Given:

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C = 200 + 0.75(Y - T)
Planned investment (I) = 100
Government purchases (G) = 100
Taxes (T) = 100

Total saving (S) = Y - T - C

Substituting the values:

S = Y - T - (200 + 0.75(Y - T))

Simplifying the equation:

S = Y - T - 200 - 0.75Y + 0.75T

Combining like terms:

S = 0.25Y - 0.25T - 200

Since planned investment (I) equals total saving (S), we have:

I=S

Substituting the equation for S:

100 = 0.25Y - 0.25T - 200

Rearranging the equation:

0.25Y - 0.25T = 300

Dividing through by 0.25:

Y - T = 1200

This equation represents the IS (Investment-Saving) function in the Keynesian cross model. It
shows the relationship between the level of output (Y) and taxes (T) when planned investment
(I) equals total saving (S).

B. what is the equilibrium level of income.

To find the equilibrium level of income in the Keynesian cross model, we need to equate
aggregate expenditure (AE) to income (Y).

In the model, aggregate expenditure is the sum of consumption (C), planned investment (I), and
government purchases (G).

Given:
C = 200 + 0.75(Y - T)
Planned investment (I) = 100
Government purchases (G) = 100
Taxes (T) = 100

Aggregate expenditure (AE) = C + I + G

Substituting the values:

AE = (200 + 0.75(Y - T)) + 100 + 100

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Simplifying the equation:
AE = 200 + 0.75(Y - T) + 200

Combining like terms:

AE = 400 + 0.75Y - 0.75T

Since at equilibrium, aggregate expenditure (AE) equals income (Y), we have:

AE = Y

Substituting the equation for AE:

400 + 0.75Y - 0.75T = Y

Rearranging the equation:

0.25Y = 400 + 0.75T

Dividing through by 0.25:

Y = 1600 + 3T

This equation represents the IS (Investment-Saving) function in the Keynesian cross model.

To find the equilibrium level of income, we set Y = AE:

Y = 400 + 0.75Y - 0.75T

Rearranging the equation:

0.25Y = 400 - 0.75T

Dividing through by 0.25:

Y = 1600 - 3T

So, the equilibrium level of income is given by Y = 1600 - 3T.

C. If government purchases increase to125, what is the new equilibrium income?

Now, if government purchases increase to 125, we substitute G = 125 into the IS function:
Y = 1600 - 3T
Y = 1600 - 3(125)
Y = 1600 - 375
Y = 1225

Therefore, the new equilibrium income is 1225.

D. What level of government purchase is needed to achieve an income of 1,600?

To achieve an income of 1600, we set Y = 1600 and solve for T:
1600 = 1600 - 3T

Rearranging the equation:

3T = 0

Dividing through by 3:
T=0

So, in order to achieve an income of 1600, taxes (T) would need to be 0.

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2)Consider the consumption function C= 200+0.75(y-t) , investment function I=200-25r ,
government purchase and tax= 100 . money supply(M)=1000 and the price level is p=2.

9. Derive IS function and LM function

To derive the IS (Investment-Saving) function and LM (Liquidity Preference-Money Supply)
function in the IS-LM model, we need to equate investment and saving, and money demand and
money supply, respectively.

Given:
Consumption function: C = 200 + 0.75(Y - T)
Investment function: I = 200 - 25r
Government purchases (G) = 100
Taxes (T) = 100
Money supply (M) = 1000
Price level (P) = 2

IS Function:
In the IS function, investment (I) is equal to saving (S).

S=Y-T-C
S = Y - T - (200 + 0.75(Y - T))
S = Y - T - 200 - 0.75Y + 0.75T
S = 0.25Y + 0.25T - 200

Setting I = S:
200 - 25r = 0.25Y + 0.25T - 200

Simplifying:
25r + 0.25Y + 0.25T = 400

Dividing through by 25:

r + 0.01Y + 0.01T = 16

So, the IS function is given by r + 0.01Y + 0.01T = 16.

LM Function:
In the LM function, money demand (L) is equal to money supply (M).

L=M/P
L = 1000 / 2
L = 500

Setting L = M / P:
500 = M / 2

Simplifying:
M = 1000

So, the LM function is given by M = 1000.

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 10. What is the equilibrium level of income and interest rate in the IS-LM model
Equilibrium level of income and interest rate:
To find the equilibrium level of income and interest rate, we need to simultaneously solve the IS
and LM functions.

IS function: r + 0.01Y + 0.01T = 16

LM function: M = 1000

Since there is no explicit equation for Y, we can substitute the given values and solve for r.

Substituting T = 100 into the IS function:

r + 0.01Y + 0.01(100) = 16
r + 0.01Y + 1 = 16
r + 0.01Y = 15

Substituting M = 1000 into the LM function:

1000 = 1000

Therefore, the equilibrium interest rate is r = 15 and the equilibrium level of income is Y = any
value.

11. Suppose that government purchases are raised from 100 to 150. What are the new
equilibrium interest rate and level of income

Now, if government purchases increase from 100 to 150, we substitute G = 150 into the IS
function:
r + 0.01Y + 0.01T = 16
r + 0.01Y + 0.01(150) = 16
r + 0.01Y + 1.5 = 16
r + 0.01Y = 14.5

Simplifying the equation:

r + 0.01Y = 14.5

Substituting T = 100 into the IS function:

r + 0.01Y + 0.01(100) = 14.5
r + 0.01Y + 1 = 14.5
r + 0.01Y = 13.5

Therefore, the new equilibrium interest rate is r = 13.5 and the new equilibrium level of income
is Y = any value.

12. Suppose instead that the money supply is raised from 1000to 1200. What are the
new equilibrium interest rate and level of income
13.