Use the classical (RBC) IS—LM—FE model to show the effects on the economy of a temporary adverse supply shock; for example, an increase in the price of oil
You should show the impact on the real wage, employment, output, the real interest rate, consumption, investment, and the price level.
The lower TFP reduces the marginal product of labor, thus shifting the labor—demand curve to the left, reducing the real wage and employment. The adverse supply shock thus shifts the FE line to the left because both TFP and employment decline. To restore equilibrium, the price level rises, shifting the LM curve left. The result is lower output and a higher real interest rate. The higher real interest rate reduces investment. The lower income and higher real interest rate reduce consumption.
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Fred's Widget Company has purchased $500,000 in equipment, which can be sold for a salvage value of $300,000 at any time. The best interest rate on alternative investments is 5%
What is the cost of using this machinery for one year? How would your answer be different if the machinery had not yet been purchased?
Which of the following determines the supply side of the market?
a. consumers b. buyers c. sellers d. government officials