Midterm 3 - Notes on Practice Qs (4)

Question 1

In the equilibrium of the partial sticky price New Keynesian model, in response to an increase in current productivity, aggregate saving increases.

T/F

Answer 1

True

Question 2

What is the New Keynesian model?

Answer 2

Question 3

What does “sticky price” mean?

Answer 3

Question 4

What is the simple sticky-price New Keynesian model?

Answer 4

This is the most stripped-down version of the NK model.

• a current productivity shock does not change the main real variables like output, consumption, and labor
• so aggregate saving does not increase either

This feels weird at first, because in real life higher productivity sounds like it should increase output. But in this simplified model, actual production is being pinned down by demand, not by productive capacity alone.

So the simple sticky-price NK model is the version where:

• **prices are sticky
• demand matters a lot
• some supply shocks do very little to real activity**

Question 5

What is the partial sticky-price New Keynesian model?

Answer 5

Question 6

What is the neoclassical model?

Answer 6

Question 7

What is aggregate saving?

Answer 7

Question 8

Why does saving equal investment in equilibrium?

Answer 8

Question 9

What does it mean if aggregate saving increases?

Answer 9

economy is devoting more resources to future production rather than current consumption

Question 10

How does each model react to a current productivity shock?

Answer 10

Question 11

Simple sticky-price NK model

output does not change
consumption does not change
labor does not change
saving does not rise

why?

Answer 11

In the simple sticky-price NK model, current productivity is not what determines short-run output. Demand does. So higher productivity does not raise output, does not raise consumption, and therefore does not raise saving.

Question 12

How would these models react to a government spending shock?

rise in government spending

Answer 12

Question 13

How would these models react to a negative demand shock?

Answer 13

Question 14

How would the models react to an expected inflation shock?

Answer 14

Question 15

Productivity shock

Example: better technology

what would happen in each model?

Answer 15

• neoclassical: strong effect
• simple sticky-price NK: little or no effect in your class version
• partial sticky-price NK: some effect

Question 16

Government spending shock

Example: government purchases rise

Question 17

why is govt spending a demand shock?

Answer 17

Question 18

What happens first when government spending rises?

Answer 18

• aggregate demand rises
• in an IS-LM picture, the IS curve shifts right
• in an AD-AS picture, the AD curve shifts right

Question 19

IS-LM picture

what are these curves?

Answer 19

Question 20

Government spending shock

Example:
government purchases rise

Usually: stronger effect in Keynesian-type models can raise output and labor when prices are sticky