Answer to Question #221264 in Macroeconomics for Ronald

Question

The IS-LM model is a simplification of the interrelationship between selected economic variables. The model consists of a number of endogenous variables (those variables whose values are determined inside the model) and a number of exogenous variables (those variables whosevalues are determined outside the model). The labour markets mostly consider the relationships between prices, expected prices, unemployment 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.

(b) In the labour market, explain how the rate of unemployment is related to the bargaining power and nominal wages.

(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.
Note: Please use diagrams to aid your explanation.

Answer 1

a

Macroeconomics is a part of economics that deals with production, decision and allocation concerning the whole economy. As economics developed as a subject that deals with the allocation of scarce resources among humans with unlimited wants, more focus was put on developing models that would describe the economic situations of any nation. 

First, the classical economy was developed, which talked about the efficient allocation of goods and services among people who needed it at an effective price rate. However, after the Great Depression, Keynes came to the picture and explained an entire new allocation system. According to him, government intervention was required to bring an economy into equilibrium. This led to the introduction of government influence in the demand and supply model. 

The IS-LM 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. On the other hand, the LM curve determines all possible income levels in the short run to bring money. 

b

Positive economics deals with facts and their facets. Like the rate of unemployment in a country, the proportion of poor in the country, etc. Normative economics deals with what the country ought to be in. E.g., How shall one deal with unemployment in the country, what schemes shall we offer to the poor,

c.

With the IS-LM 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 am 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 utilises all its output and employs all labour and capital, it is producing at the optimal or natural level.