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mambovipi

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Can someone please explain the following:

Productivity shock:
- decrease in LRAS --> decrasein GDP --> increase in prices.

Feedback rule to deal with it:
I don't understand the point here. Focus on GDp and an increase in gdp in the long run will just increase prices. Focus in prices, you decrease supply and prices in the long run are constant, with gdp lower. In a productivity shock WHY would you want to decrease supply?
 
The keynesian feedback rule will look to address either stabalizing real gdp back to potential gdp or will stabalize price.

To stabalize potential GDP, they have to increase the money supply in order to spur aggregate demand. By doing so, the equilibrium point will move back to a spot on the LAS curve, but at a higher price.

To stabalize price, the only option is to cut the money supply, reducing aggregate demand, and further shifting the real gdp point to the left AWAY from LAS.
 
picking up from above:

According to the feedback rule with productivity shocks, in order to stabilize the price level the most likely action by the Fed and the resulting effect on real GDP, respectively, are:
Fed�s action Effect on real GDP
A. Fed decreases the quantity of money the real GDP declines
B. Fed decreases the quantity of money the real GDP remains constant
C. Fed keeps the quantity of money constant the real GDP declines
D. Fed keeps the quantity of money constant the real GDP remains constant

So in this case the answer is B. However how does real GDP stay constant if the fed is decreaseing LRAS?

Decrease in money supply leads to a new equilibrium at a lower output lower gdp but unchanged prices.

WHAT am I missing here??? This is driving me crazy
 
Yeah the explanation for this in mock 2 is a little dicey...it says price level and real gdp is unchanged
 
mcf, very good explanation. thanks a lot, I get it now. however in reference to the above Q can you help me out?
 
The productivity shock is balanced with the decrease in the quanity of money to keep GDP stable.
 
but if you are decreasing LRAS then gdp WILL change in the LR
 
Not if the productivity shock already increased the the supply. The Fed is counteracting the increase.
 
Well, the feds ultimate goal is price stability, not GDP stability. GDP stability is secondary.

So, the fed would look to decrease the money supply and real gdp would move to a lower point. Are you certain it's B. I'm 100% for A.
 
Well in the almighty wisdom of the cfai they don't give answers but here's the bullsht from the PDF:
"According to the feedback rule, when the price level rises the Fed decreases the quantity of money in order to reduce aggregate demand. As a result, the price level as well as the real GDP would remain constant."

I think it's A as well.
 
What they've described should return price to its original level and reduce real GDP even further...confusing
 
I honestly think this has to be a mistake. Very confident of that conclusion. You cannot have both real gdp and price stabalize. That's sort of the whole point that they highlight in the text.

Whoever wrote the response is human too and they probably goofed. Or maybe they meant to say that potential GDP remains unchanged, because there would be no impact to the LAS/natural rate of unemployment in the long term.
 
I agree, thanks for your help, really cleared it up in my head.
 
I agree, this has to be A... If you draw it out, there is no way that GDP stays the same with a decrease in money supply..

Both LAS and SAS shift left, and then AD shifts left in response to the Fed's action. This keeps price level the same as where it started and GDP declines further.
 
productivity shock decreases potential GDP by itself .. doesn't it ?
 
I agree with A as well, however, I'm not too certain as to the timeframe that LRAS will take to move to the new Real GDP point.
 
mambovipi Wrote:
-------------------------------------------------------
> Well in the almighty wisdom of the cfai they don't
> give answers but here's the bullsht from the PDF:
> "According to the feedback rule, when the price
> level rises the Fed decreases the quantity of
> money in order to reduce aggregate demand. As a
> result, the price level as well as the real GDP
> would remain constant."
>
> I think it's A as well.

B

I think the answer is B and however has written this statement is correct bcoz, as there is already a productivity shock and the LRAS has shifted to the left, price level has risen. According to the feedback rule feds will lower money supply shifting AD down and price level will get back to its original level but GDP remains constant bcoz GDP has already been reduced by the productivity shock. refer to econ cfai text pg 474 figure 6

point to make: cfai does not make things easy, and A was just a eye-catcher beware of them
 
madanalyst:

I thought of that possibility. But after a production shock (when AS shifts upwards and to the left), if the money supply is reduced, the AD would shift downwards to the left (reduction in AD) and the net effect would be to have a lower price (maybe the ame price) but NOT the same real GDP. The new eq. would have lower GDP !!!!! What say others???



Edited 1 time(s). Last edit at Thursday, June 5, 2008 at 04:18PM by krisC.
 
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