Question one.

9. (5 pts.) Show on the axes below how the presence of trade unions can impact the structural rate of unemployment in a country:

Wage

(3 pts.) Considering the process of fractional reserve banking, which reserve ratio would allow the smallest ultimate impact on the money supply, 17% or 6%? Why?

(4 pts.) An initial $3 billion increase in the money supply by the Federal Reserve resulted in an overall increase of $18 billion in the money supply.

What is the size of money multiplier?

What is the reserve ratio %?

Quantity of Labor

12.

(3 pts.) What is the method the Fed uses most frequently to change the money supply?

(4 pts.) Describe how this process alters the money supply:

13.

a. (3 pts.) Define each of the variables in the following equation: M V = P Y

b. (4 pts.) Applying the Quantity Equation and assuming that velocity is constant, what will be the rate of inflation if real GDP grows 4.5% in a given year and the money supply only increases 2.2%?

14. The figure below shows the market for loanable funds (in an open economy), net capital outflow and the market for foreign currency exchange.

(5 pts) Show how the graphs would be affected if a new tax increase on dividend income from stocks incentivizes people to save less.

(3 pts) How would this affect the real interest rate?

(3 pts) How would it affect the real exchange rate?

Real Interest Rate

Real Interest Rate

Quantity of Loanable Funds

Quantity

Real Exchange Rate

Quantity of Dollars

15. The figure below shows the market for loanable funds (in an open economy), net capital outflow and the market for foreign currency exchange.

(5 pts) Show how the graphs would be affected if China experienced an unexpectedly large crop of soybean one year and so decided to import less soybean from the United States (ie. US exports of soybean decreased significantly).

(3 pts) How would this affect the real interest rate?

(3 pts) How would it affect the real exchange rate?

Real Interest Rate

Real Interest Rate

Quantity of Loanable Funds

Quantity

Real Exchange Rate

Quantity of Dollars

16.

a. (3 pts.) Draw the Model of Aggregate Demand and Aggregate Supply you would use for

analyzing short and long-run fluctuations in the U.S. economy.

Price

(3 pts.) Use the graph to show the impact of the following event:

A large drop in the stock market causes businesses to become more pessimistic and reduce their level of investment.

(4 pts.) What happens to the price level in the short-run and long-run? (describe what happens in both cases)

(4 pts.) What happens to output in the short-run and long-run? (describe what happens in both cases)

Income, Output (Y)

e. (4 pts.) If the government wished to avoid the negative effects of a recession following the fall in investment, what could it do? How would this impact the AD-AS model? (just describe in words, there is no need to illustrate on the graph)

17. (4 pts.) If the initial impact on Aggregate Demand of a new airport security program amounts to $42 billion and the Marginal Propensity to Consume is 0.75, what would be the total impact on Aggregate Demand if a crowding out effect of $14 billion also occurs?

18.

a. (4 pts.) How does the Theory of Liquidity Preference explain the downward slope of the

AD curve?

b. (4 pts.) How does the Theory of Liquidity Preference explain why the AD curve shifts inward when the Fed decreases the money supply (M)?

19.

a. (3 pts.) Draw a graph showing the long-run and short-run Phillips curves (draw both

curves on the same axes below).

Inflation Rate

(3 pts.) Show a point on the short-run Phillips curve and indicate what would happen to that point in the short run if the Federal Government significantly increased its expenditures in an effort to stimulate the economy.

(4 pts.) If a newly invented mathematical algorithm was widely rolled out which can match unemployed people to their ideal job much more quickly, would this shift the long or short run Phillips curve? In which direction would the curve shift? (just describe, there is no need to show on the graph)

(3 pts.) How would the situation described in question 19c above affect the long-run aggregate supply curve?

Unemployment Rate

(4 pts.) If oil prices fell causing a positive supply shock, would this shift the long or short run Phillips curve? In which direction would the curve shift? (just describe, there is no need to show on the graph)

(4 pts.) In the AS-AD Model, would the situation described in question 19e above shift the SRAS, the LRAS or the AD curve? In which direct would the curve shift?

(3 pts.) Would the situation described in question 19e above cause 'stagflation'?

20. (5 pts.) Provide two examples of events that could shift the LRAS curve. Say in which direction the curve would shift, and also how the event would affect the long-run Phillips curve.

21. (5 pts.) What are three key lessons you will remember from taking ECON 204 Principles of Macroeconomics?

Question two.

Consider a two-period small open economy populated by a large number of

identical households with preferences described by the utility function

lnCT 1 + lnCN 1 + lnCT 2 + lnCN 2

where CT 1 and CT 2 denote consumption of tradables in periods 1 and 2, respectively, and CN 1 and CN 2 denote consumption of nontradables in periods

1 and 2. Households are born in period 1 with no debts or assets and are

endowed with L1 = 1 units of labor in period and L2 = 1 units of labor in

period 2. Households o?er their labor to ?rms, for which they get paid the

wage rate w1 in period 1 and w2 in period 2. The wage rate is expressed in

terms of tradable goods. Households can borrow or lend in the international ?nancial market at the world interest rate r?. Let pN 1 and pN 2 denote the

relative price of nontradable goods in terms of tradable goods in periods 1

and 2, respectively.

Firms in the traded sector produce output with the technology QT 1 = aTLT 1 in period 1 and QT 2 = aTLT 2 in period 2, where QT t denotes output in period t = 1,2 and LT t denotes employment in the traded sector in period t = 1,2.

Similarly, production in the nontraded sector in periods 1 and 2 is given by

QN 1 = aNLN 1 and QN 2 = aNLN 2 .

1. Write down the budget constraint of the household in periods 1 and 2.

2. Write down the intertemporal budget constraint of the household.

3. State the household's utility maximization problem.

International Macroeconomics, Chapter 9 299

4. Derive the optimality conditions associated with the household's max

imization problem.

5. Derive an expression for the optimal levels of consumption of trad

ables and nontradables in periods 1 and 2 (CT 1 , CN 1 , CT 2 , and CN 2 ) as functions of r?, w1, w2, pN 1 , and pN 2 .

6. Using the zero-pro?t conditions on ?rms, derive expressions for the real wage and the relative price of nontradables (wt and pN t , t = 1,2),

in terms of the parameters aT and aN.

7. Write down the market clearing condition for nontradables.

8. Write down the market clearing condition for labor.

9. Using the above results, derive the equilibrium levels of consumption ,

the trade balance, and sectoral employment (CT 1 , CT 2 , CN 1 , CN 2 , TB1, TB2, LT 1 , and LT 2 ) in terms of the structural parameters aT, aN, and r?.

10. Is there any sectoral labor reallocation over time? If so, explain the

intuition behind it.

Part B .

Answer the following questions according to the instructions given.

Use the information in the T-account for a single bank to answer questions 6- in Assets Liabilities Total Bank Reserves $100.000 Checkable Deposits $500,000 Loans $400,000 6. If the required reserve ratio is 20%, then required reserves are equal to: SO. b. $5,000. $15,000. $100,000. 7. If the required reserve ratio is 20%, then excess reserves are equal to: a. b. $5,000. $15,000. $115,000. If the required reserve ratio is 20%, then the maximum additional amount this bank can lend is: SO. b. $5,000. C. $15,000. d. $115,000. 9. If the required reserve ratio is 20% and this bank is *fully loaned up' (i.c., makes loans until excess reserves are equal to zero), then the bank's total loan assets will be equal to: a. $100,000. b. $400,000. C. $500,000. $1,000.000. 10. If the required reserve ratio is 20%, the simple deposit multiplier is equal to: 4. b. 5. C. 8. d. 12.5. Chapter 10 Assignments 214BANKING AND MONEY CREATION 1. Which of the following is correct? a. b. Total bank reserves = excess reserves/required reserves C. Total bank reserves = excess reserves + required reserves d. Excess reserves = total bank reserves + required reserves Required reserves = (excess reserves) x (total bank reserves) 2. Mr. Jones deposited $5,000 cash into his account at Bank A. If the required reserve ratio is 10%, Bank A has to keep equal to in the form of required reserves and can make a loan a. $500; $4,500 b. $1,000; $4,000 C . $500; $5,000 $5,000: $0 3. To support checkable deposits, banks are legally required to hold reserves equal to: a. total checkable deposits. b. vault cash. C. total checkable deposits multiplied by the required reserve ratio. d. total checkable deposits divided by the required reserve ratio. If the required reserve ratio is 10%, the banking system has total reserves in the amount 4. of $40 billion, there are no currency leakages, and each bank makes loans until excess reserves equal zero, then total checkable deposits for the banking system will equal: a. $10 billion. b. $40 billion. C. $200 billion. d. $400 billion. If the required reserve ratio decreases from 10 percent to 8 percent: 5. a. potential deposit expansion decreases. b. potential deposit expansion increases. the simple deposit multiplier decreases from 12.5 to 10. C. the simple deposit multiplier increases from 10 to 12.5. d. e . Both b. and d. are correct.plain how this development affects the interest rate, output, and investment. 2 The following questions deal with the medium-run correction in a closed economy after it is perturbed by a negative shock. (a) Combine the Phillips Curve (PC) equation 7 -7 = m+z-au with the production function Y = N to obtain the following alternative expression for the PC. IT - Te = ( Y - Yn) In your answer briefly define the variables used in the above relations. Suppose that the economy is initially in a medium-run equilibrium, in which the actual and expected inflation rates are 2% and inflation expectations are anchored at 7 = 2%, but then, due to a fall in business confidence, investment spending significantly falls. In parts (b), (c) and (d) below explain in words and illustrate using both the IS-LM model and the PC. (b) Describe the impact of the fall in business confidence in the short run. How does the short- run equilibrium output and inflation rate compare to the initial medium-run equilibrium output and inflation rate if the central bank does not change the real policy rate? MATHOO02 5 TURN OVER (c) Describe the medium run correction process. Be sure to discuss the change in output, inflation and interest rate. (d) In the course of the medium run correction, does the economy face the possibility of running into a liquidity trap? If so, propose alternative policies to get the economy out of the liquidity trap