AMBIGUITY IN EXTENT OF SHIFT OF Yd/YS IN G1

Y1 increases unambiguously.
Effect on r1 is ambiguous as it depends on the extent of shift of Y d and YS curves. Since it is a
temporary change in G1, the effect on lifetime wealth is small, and hence N S and YS does not
change very significantly. Yd shifts by G1. Hence, Yd shifts to the right more than YS.

RESTORING Yd/YS EQUILIBRIUM

At the original equilibrium interest rate of r1, output demand (point A on Yd ) is more than
output supply (point B on YS ). Hence, goods market cannot be in equilibrium. To restore
equilibrium, interest rate needs to rise. A rise in interest rate means that consumers want to
save more today, so they consume less today, C1 falls (substitution effect of interest rate
change dominates). A rise in interest rate also means that the rate of return on alternative
asset to (bonds) increases, so I1 falls. Hence, there is a movement along the Yd curve upwards
from point A. At the same time, as interest rate rises, representative consumer works more,
since the price of leisure today is more expensive relative to the price of leisure tomorrow and
this substitution effect dominates, so NS starts to shift to the
right, thus causes a movement up along YS curve from point B.

CROWDING OUT EFFECT

In the monetary intertemporal model, government spending crowds out private spending as C
and I falls due to an interest rate. Y1 G1.

Representative Firm Maximization Problem

Money

Measures of money supply

Money neutrality
Change in quantity of money leaves real variables unachanged.

Cash-In-Advance Model
Friedman-Lucas Money Surpise Model
Real Business Cycle Models
TFP shocks in RBC Model persistent increase in current and future TFP
Credit Market Imperfections