Question;Economics;304;Homework;- Lesson 10;70;points;Instructions:Please;show all work or points will be taken off. Good luck!;1. (30 points) As we;can see from the graphic below, the simulated real business cycle (RBC) model;fits real world data quite well with the exception of average labor;productivity (the bars on the far right hand side of the graphic). In;particular, the real world data suggests that average labor productivity is;weakly pro-cyclical with the correlation between average labor productivity and;output between 0.3 and 0.4. The simulated correlation from the RBC model over;0.8, clearly not consistent with the facts.;Given these results, we say that the simulated RBC model implies that;average labor productivity is more pro-cyclical than it actually is.;We then argued that when we add fiscal (Government spending);shocks to the RBC model, this " average labor productivity is too;pro-cyclical" problem is lessoned since the theory implies that in a;fiscal shock world, all else constant, average labor productivity tends to be;slightlycounter-cyclical. In the;space below, explain in detail how average labor productivity is slightly;counter-cyclical in a "fiscal shock" world. Be sure to support your arguments with a;labor market diagram and a production function labeling the initial equilibrium;(before the fiscal shock) as point A and the subsequent equilibrium (after the;fiscal shock) as point B. Be sure to;explainexactly why workers and;firms change their behavior given the fiscal shock. Finish your essay by;commenting on how the RBC theorists felt about discretionary counter-cyclical;fiscal policy and why (i.e., "hands off" or "hands on?").;Write your essay here - be sure to refer to your graphs in;your discussion.;2. (40 points total);When Milton Friedman and Anna Schwartz in a book titled:A Monetary History of the United States, 1867-1960 uncovered the;empirical reality that money is 'pro-cyclical' and 'leading,' the classical;economists "went to the drawing board." We discussed how the RBC theorists explained;this phenomenon through reverse causation.;We also discussed how the New Classical school explained this phenomenon;via the Lucas Island Model.;(20;points) In the space below, provide the RBC explanation as to why;money is leading and pro-cyclical. Be;sure to include a money market diagram, an IS-LM diagram, and an AS/AD diagram;in your answer being sure to refer to;your graphs in your essay. Finish;your essay by discussing whether or not money is neutral in the RBC model and;why.b) (20 points) In the;space below, use the "Lucas Island Model" to provide an explanation;as to why;money is leading and pro-cyclical according to the New Classical;Economists. Be sure to include a;completely labeled AS/AD diagram and an explanation of what we mean exactly by;a Lucas Aggregate supply curve (along with the intuition underlying it). Finish your essay by discussing whether or;not money is neutral in this New Classical model and why.
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