Answer to Question #220527 in Macroeconomics for bunnybear

Question

The IS-LM model is a simplification of the interrelationship between

selected economic variables. The model consists of a number of en-

dogenous variables (those variables whose values are determined inside

the model) and a number of exogenous variables (those variables whose

values are determined outside the model). The labour markets mostly

consider the relationships between prices, expected prices, unemploy-

ment among other macroeconomic variables.

(a) Explain endogenous and exogenous variables in the IS-LM model

as well as the labour markets, derive the AD-AS model.

(10 marks)

(b) In the labour market, explain how the rate of unemployment is

related to the bargaining power and nominal wages.

(5 marks)

(c) As a policy consultant, use the AD-AS framework to explain how

the health of the South African economy can be improved given

you diagnosis in question 1.

(15 marks) Note: Please use diagrams to aid your explanation.

Answer 1

a)The IS-ML model stands for Investment Savings (IS) and Liquidity preference-Money Supply (LM). Developed as a Keynesian macroeconomic model, this is used to study and understand how the loan and funds markets interact with the money market. The IS-LM curve is graphically represented to show short-run equilibrium between an economy's output and interest rate. 

The IS curve describes all possible interest levels and output at which investment equals savings. The LM curve on the other hand determines all possible income levels in the short run to bring money.

The exogenous variables that are not per-determined in the IS-LM model are investment and consumption. The interest rate and the level of output are two endogenous variables that are predetermined. 

 

With the IS-ML model, the AD and AS curve determines which represents the level of national income and price level. Aggregate demand is the total amount of goods and services demanded in an economy that domestic individuals and foreign individuals demand along with the government of that country. The aggregate demand can be written as:

AD = C+I+G+(X−M)

Here, C is consumption

     I is level of investment in the economy

     G is the level of government spending and,

     (X-M) stands for net exports which is the difference between exports and imports during the same time period. 

Aggregate supply is the total amount of goods and services produced in the economy in the same time period. The aggregate supply is said to have a positive relationship between the output or real GDP of a country with the price level. As the supply curve, it is a positive and upward sloping curve. The formula for aggregate supply is:

Y =  Y*

This describes that when an economy is utilizing all its output and employing all labor and capital, it is producing at the optimal or natural level.

b)Unemployment decreases the bargaining power of individuals due to lack of income. on the other hand reduced wages increase the rate of unemployment.

c)The health sector can be improved by increasing government expenditure on the health sector.