BECO1001 Section 004/005/006/007 Written Exercise 2

1. In an economy MPC is constant and the full employment level of output is 6,500.

(b) What are the government spending multiplier, tax multiplier, and balanced-budget multiplier?

(c) What are the consumption function and saving function?

(d) What amount of change in government spending is required to achieve full employment and what will be the consumption, saving, and budget deficit after the change?

(e) What amount of balanced-budget changes in government spending and tax are required to achieve full employment and what will be the consumption, saving, and budget deficit after the change?

2. Let C=120+0.6Yd, I=140, G=200, T=100.

(a) What are government spending multiplier, tax multiplier, and balanced-budget multiplier?

(b) What are the output, consumption, saving, and budget deficit at the equilibrium?

(c) What are the output, consumption, and saving if the government changes the budget deficit to 50 by a change in G.

(d) What are the output, consumption, and saving if the government changes the budget deficit to 50 by a change in T.

3. The central bank holds $1,800 in government securities. The commercial banks have deposited $500 with the central bank and hold $100 in vault cash. $900 are held as currency by the public. The required reserve ratio is 20%. Banks are loaned up.

(a) Fill the central bank’s T-account below.

(b) What is the money supply?

(c) The central bank would like to change the money supply to $3,300 either by an open market operation or a change in the required reserve ratio.

(i) What should be the new ratio if the required reserve ratio is changed?

(ii) How much government securities should be purchased/sold if an open market operation is undertaken?

(d) What will be the changes in interest rate and security price after the change in (c)?

                 Just write ↑, ↓, or unchanged

4. Let Md=2,000-20,000r+0.5P.Y, P.Y=10,000, and Ms=5,000.

(a) (i) Draw in the graph above the money demand curve and the money supply curve.

(ii) What is the equilibrium interest rate?

(b) If the nominal income P.Y rises 20% and the quantity of money supplied Ms does not change,

(i) Draw the new money demand curve in the graph above.

(ii) What is the excess demand or supply of money before the interest rate change?

(iii) What is the new equilibrium interest rate?

(c) If the nominal income rises 20% and the central bank wants to keep interest rate unchanged,

(i) how much government securities should it buy or sell in the open market if the required reserve ratio is 14% and private banks do not hold excess reserves?

(ii) Draw the new money supply curve in the graph above.

5. The graph below shows the Fed rule curve and the current equilibrium of an economy in which

- P is fixed

- MPC=80%

- planned investment increases $40 whenever interest rate decreases 1%

(a) Draw the IS curve in the graph above.

(b) If tax (T) decreases $125,

(i) Draw the new IS curve in the graph above.

(ii) What are the interest rate and output at the new equilibrium?

(iii) What are the changes in planned investment and changes in output from the current equilibrium to the new equilibrium?

(c) What is the tax multiplier?

6. The graph below shows the current equilibrium in an economy (YP: potential output).

If autonomous consumption increases,

(a) Show the SR and LR changes in the graph above.

(b) What are the changes in output, interest rate, and price level from the current equilibrium to the new short-run equilibrium?

Just write ↑, ↓, or unchanged

(c) What are the changes in output, interest rate, and price level from the current equilibrium to the new long-run equilibrium ?

7. The IS/Fed rule diagram and AS/AD diagram below show the current equilibrium in an economy.

Let the potential output be 200.

(a) What are the current output, interest rate, and price level?

(b) What will be the output, interest rate, and price level in the long run?

(c) What will be the output, interest rate, and price level in the long run if the government use fiscal policy to immediately push the economy to full employment?

8. (a) An economy is currently far below capacity. Show the short-run changes in the AS/AD graph below and predict the changes in the price level and aggregate output if firms increase capital investment.

↑ or ↓? How much?

(b) An economy is currently near capacity. Show the short-run changes in the AS/AD graph below and predict the changes in the price level and aggregate output if the central bank raises the required reserve ratio.

(c) Show the short-run changes in the AS/AD graph below and predict the changes in the price level and aggregate output if energy price increases in the world market and the central bank tries to limit the rise of the price level.