Intermediate Macroeconomics II (Coursework Sample)

ASSIGNMENT 1
Name:
Econ 2480: Intermediate Macroeconomics II
Date:
PART 1
Conventional economic theory states that money is neutral. This is because alteration in the supply of money does not necessarily interfere with the ‘real’ economy that is, production, consumption and patterns of trade. The sole interaction between money and the economy is through determination of nominal quantities such as wages, exchange rates and prices among others. Though alteration in the quantity of money may trigger short-term disruptions, the economy eventually settles at the same long-term equilibrium as the previous one. In other words, the neutrality of money is based on the claim that at when money is at ‘normal’ levels, a shift in the supply of money will not change the long-term economic equilibrium. Money is neutral due to the fact that it does not affect the output and the interest rate in the medium run. The rise in nominal money supply is proportional to the rise in the price level. The natural level of output is determined by the AS curve position while the IS curve determines interest rate. Since the IS curve does not shift, the interest rate is not affected, as well as the output level. As a result, in the medium run, the monetary policy remains ineffective.[Edward Gamber and Colander David, Macroeconomics (South Africa: Pearson, 2009), 197]
Though money is neutral in the medium run, monetary policy can be efficient in the short-run. With a monetary expansion, the AD curve shifts to the right while the LM curve shifts down. As a result, there is a decrease in the interest rate thereby increasing the output due to increase in investment. In other words, the usefulness of monetary policy is evident in the short-run because, it decreases the interest rate while increasing the output level. In case the output level falls below the natural level, monetary policy can speed up the economy’s return to the natural level. However, monetary policy is not effective when the LM curve is flat (interest rates close to zero). This is because, during this time, the economy is said to have fallen into a ‘Liquidity Trap.’ Monetary policy is useful since it can speed up the return of output to its normal level if it deviates in the short-run.
Situations may arise when the interest rate has no effect on investment. An example of such a situation is; when financial markets perform poorly and corporations cannot borrow from them. Such firms, therefore, finance investments through retained earni...