Consider Two Economies with the Following IS Curves, Denoted 1 $\tilde { Y } _ { 1 t } = \bar { a } - \bar { b } _ { 1 } \left( R _ { t } - \bar { r } \right)$

question 36

Multiple Choice

Consider two economies with the following IS curves, denoted 1 and 2:
IS₁: $\tilde { Y } _ { 1 t } = \bar { a } - \bar { b } _ { 1 } \left( R _ { t } - \bar { r } \right)$
IS₂: $\tilde { Y } _ { 2 t } = \bar { a } - \bar { b } _ { 2 } \left( R _ { t } - \bar { r } \right)$
Given these two curves, the economies are identical except that they respond to interest rate changes differently. Suppose we assume $\bar { a } = 0 , \bar { b } _ { 1 } = 1 , \bar { b } _ { 2 } = 0.5 , R _ { t } = \bar { r } = 5 \%$ ) If the real interest rate in each economy falls to $R _ { t } ^ { \prime } = 4 \%$
Then:

• A) Country 1 will move from its long-run equilibrium to 1 percent above its potential and Country 2 will move from its long-run equilibrium to 0.5 percent above its potential
• B) Country 1 will move from its long-run equilibrium to 1 percent above its potential and Country 2 will move from its long-run equilibrium to -0.5 percent below its potential
• C) Country 1 will move from its long-run equilibrium to -1 percent below its potential and Country 2 will move from its long-run equilibrium to 0.5 percent above its potential
• D) Country 1 will move from 0.5 percent below its potential to its long-run equilibrium and Country 2 will move from its long-run equilibrium to 2 percent above its potential
• E) neither country will move away from its long-run equilibrium

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