Discuss the real business cycle model

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Assignment:

Consider the Real Business Cycle (RBC) Model studied in Lecture notes 6-7-8. Suppose there is an increase in the importance of leisure, i.e., θ in the utility function in Problem 1 increases.

1. Use the equilibrium diagrams of the RBC Model (i.e., diagrams for the current labour market and for the current goods market) to determine the impact of this shock on current wages, current employment, the current real interest rate, and on current output. Explicitly state any assumptions you make.

2. How does the composition of output change after the shock? Explicitly state any assumptions you make.

3. How does the shock affect the Price level? Explicitly state any assumptions you make. Now assuming the Central Bank has nominal GDP target, what will be the response of the Central Bank to this shock? Use a diagram to support your answer.

Reference no: EM133270039

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