A number of persons had incorrect answers for the first two questions in Assignment #3.
1. As Md = f(r) but not a function of Y => Md is downward sloping but it does not shift for changes in Y. Thus, there is only one equilibrium r, no matter what the level of Y is. Therefore, the LM curve is horizontal.
2. You need to read the chapter on AD - AS for this. Yf is obtained when labor market equilibrium occurs (where labor demand = labor supply). This gives L*, which when plugged into the production function gives Y* (or Yf).
3. The data you obtained was for the nominal interest rate (the 10-year constant maturity rate) and the real interest rate (the Treasury-Inflation Indexed note). The basic formula to relate these is:
Real r = Nominal r - expected inflation
Solve this for expected inflation:
Expected inflation = Nominal r - Real r
The result is what is referred to as the "TIPS spread." It provides a real-time measure of the value of inflation expectations for the next 10 years (in this case). REFER TO THIS IN THE FUTURE AFTER YOU COMPLETE THIS COURSE -- IT IS VERY IMPORTANT AND OFTEN REFERRED TO.
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