There Is an Election Coming Up A If the Conservatives Can Move First, What Will Be

question 64

Essay

There is an election coming up. Conservatives are currently in government, and will be able to raise more money for the next election campaign if they keep interest rates and unemployment low. Conservatives can persuade firms whether or not to raise prices; Liberals can persuade the Bank whether or not to increase interest rates. The amount of money raised by each party and the resulting inflation and unemployment rates are given below. $$\begin{array} { l l l } & \text { Raise prices } & \text { Don't raise prices } \\\hline \text { Conservative strategy } & \text { Outcome A } & \text { Outcome B } \\\text { Raise } r & \text { Cons.: \$40 } & \text { Cons.: \$80 } \\& \text { Libs.: \$60 } & \text { Libs.: \$20 } \\& \pi = 8 \% & \pi = 0 \% \\u = 8 \% & u = 6 \% \\\text { Liberal strategy } & & \\& \text { Outcome C } & \text { Outcome D } \\\text { Don't raise } r & \text { Cons.: \$20 } & \text { Cons.: \$60 } \\& \text { Libs.: \$80 } & \text { Libs.: \$40 } \\& \pi = 12 \% & \pi = 4 \% \\u = 9 \% & u = 8 \%\end{array}$$ a. If the Conservatives can move first, what will be the outcome of this game?
b. Now suppose the Liberals move first. What will be the outcome?
c. Suppose the roles are reversed and Liberals can influence prices, while Conservatives influence the money supply. What is the outcome if Liberals move first? If Conservatives move first?

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Definitions:

Tangent

A straight line that touches a curve at a single point without crossing it, often used to find the slope of the curve at that point.

Substitution Effect

The change in the quantity demanded of a good that results from a change in price, making the good more or less expensive relative to other goods.

Wage Increase

An upward adjustment in the amount of money that workers are paid per hour, day, or work performed.

Labor Supply

The total hours that workers wish to work at a given wage rate.