Unit 1 + 2
DOUBLE POINTS
Country X and Country Y are trading partners, and both produce furnaces and solar panels. The countries can produce the following amounts using equal amounts of resources.
Country X: 6 furnaces or 8 solar panels
Country Y: 6 furnaces or 12 solar panels
Which country has an absolute advantage in producing solar panels? Which country has the comparative advantage in furnaces?
Country Y has the absolute advantage in solar panels.
Country X has the comparative advantage in furnaces as it will cost them less to produce with an OC of 1.3 solar panels compared to Country Y at 2 solar panels.
If a change in aggregate demand results in a recession, how will the price level and real output change in the short run?
Both PL and real Output will decrease.
In a country in which the banking system has limited reserves, the central bank can influence the supply of money.
Assume that the central bank targets a lower policy rate.
What open market operation can the central bank use to achieve the lower target?
What will happen to the price of government bonds?
Which model will reflect this action? Why?
The central bank will buy government bonds.
The price of government bonds will increase.
Money Market. This is an economy in a limited reserve system and the model tracks the actions of monetary policies within this system.
If the government implements an expansionary fiscal policy, what action can the central bank take to maintain a stable interest rate, assuming the banking system has limited reserves?
Buy Bonds
Decrease the Reserve Requirements
Italy and Japan are trading partners and have flexible exchange rates. The Italian currency is the euro and the Japanese currency is the yen.
Suppose that the exchange rate between the euro and the yen is 1 euro = 100 yen. What is the price of an Italian coat in yen if the coat costs 120 euros in Italy?
The price of the coat is 12,000 yen.
The following statistics are from the country of Pattiland in 2016; dollar values are measured in 2016 dollars.
Consumption = $90; Investment = $65; Transfer Payments = $45; Exports = $25; Imports = $50; Government Spending = $50; Taxes = $20.
Current population is 50 with a deflator of 90.
Calculate:
nGDP, rGDP, and rGDP per capita.
nGDP is $180
rGDP is $200
per capita is $4
Assuming no government policies are taken, what will occur in the long run if the actual unemployment rate exceeds the natural rate of unemployment?
Wages will fall, causing SRAS to shift to the right.
Assume a country’s economy is currently in recession.
Assuming the banking system has ample reserves, identify one action the central bank can take to help the economy recover from the recession. Explain the effect on policy rate utilizing the reserve market model.
Interest on reserves/administered interest rate/discount rate
A decrease in interest on reserves will decrease the demand curve, causing policy rates to decrease.
According to the quantity theory of money, if the money supply is $40 billion, real output is $100 billion, and the price level is 1.2, what is the velocity of money?
3
Assume that households in Econland increase their savings for retirement.
What will happen to real interest rates due to the increase in savings, and then what will happen to Econland’s purchases of foreign assets? Explain.
Due to the increase in savings, real interst rates will decrease due to
Econland’s purchases of foreign assets will increase. Econland’s investors will seek higher returns in other countries, which increases Econland’s demand for foreign assets.
*DOUBLE POINTS* (2 part question)
Assume that in the country of Zeta, the civilian noninstitutional population aged 16 and over is 1,000,000. The labor force participation rate is 70%, the unemployment rate is 9%, and the natural rate of unemployment is 5%.
Calculate the number of unemployed people in Zeta AND EXPLAIN if the economy is currently experiencing a recessionary gap, an inflationary gap, or no output gap.
1. Unemployed people: 63,000
- UE people = UE rate x LFPR x Population
- 9% x 70% x 1 million = 63,000
The country of Zeta is currently experiencing a recessionary gap and that the current unemployment rate (9%) is higher than the natural rate of unemployment (5%).
DOUBLE POINTS
How does each of the following changes affect the real gross domestic product and price level of an open economy in the short run? Explain each.
(a) An increase in the price of crude oil, an important natural resource
(b) A technological change that increases the productivity of labor
(c) An increase in spending by consumers
a. real GDP will fall and the price level will rise, because the increase in the price of oil raises input costs and causes the short-run aggregate supply curve to shift to the left.
b. real GDP will rise and the price level will fall, because the increase in labor productivity reduces unit input costs and causes the short-run aggregate supply curve to shift to the right.
c. real GDP will rise and the price level will rise, because the increase in spending causes the aggregate demand curve to shift to the right.
The central bank sells $15,000 worth of bonds in the open market to Jason, who withdraws cash from his checking account at State Bank to pay for the bonds. The banking system has limited reserves, the required reserve ratio is 5%, and banks do not hold excess reserves.
What is the amount by which State Bank’s liabilities change as a result of Jason’s cash withdrawal? Explain.
Have Jason’s financial asset holdings increased, decreased, or stayed the same? Explain.
State Bank’s liabilities decrease by $15,000, and checking accounts are demand deposits, liabilities to commercial banks.
Jason’s financial asset holdings have stayed the same, as the decrease in Jason’s checking account was offset by the increase in Jason’s bond holdings.
Explain how each of the following will affect long-run aggregate supply (potential real gross domestic product).
An increase in the government deficit following a reduction in personal income taxes.
An increase in the quantity and quality of education
An increase in the rate of savings
1. Deficit causes higher interest rates, less investment, and less capital causing LRAS to shift to the right.
2. An increase in education will increase human capital and cause LRAS to shift to the right.
3. An increase in savings will shift SLF to the right, lowering real interest rates, and causing investment to increase due to lower rates. With the increase in investment, capital stock will increase and cause LRAS to shift to the right.
The United States and South Korea are trading partners, and the United States has a zero current account balance. Assume now that the inflation rate in the United States decreases relative to the inflation rate in South Korea.
Based on the decrease in the inflation rate in the United States, will United States exports to South Korea increase or decrease?
United States exports to South Korea will increase.
The United States current account will be in surplus.
The United States gross domestic product will increase and that higher U.S. exports increase AD (or that production increases to meet the increased export demand from South Korea).
Country A can produce a maximum of 60 hammocks or 40 looms, while Country B can produce a maximum of 40 hammocks or 20 looms.
Internationally, if 1 loom is traded for 1.75 hammocks, who will benefit from trading: Country A only, Country B only, both countries, or neither country? Explain using numbers.
Both countries will benefit from trade, as Country A currently has an OC of 1.5 hammocks for every 1 loom, allowing them to extend production and trade with Country B in order to get hammocks.
Policymakers are pursuing a fiscal policy. Assume that the marginal propensity to consume is 0.8 and the value of the economy's recessionary gap is $300 billion.
If the government changes its spending without changing taxes to eliminate the recessionary gap, calculate the minimum required change in government spending.
However, if the government changes taxes without changing government spending to eliminate the recessionary gap, will the minimum required change in taxes be greater than, smaller than, or equal to the minimum required change in government spending in above? Explain.
Government Spending minimum change is $60 billion.
If taxes changed, the minimum required change in taxes will be greater than the minimum required change in government spending, because the tax multiplier is smaller than the government spending multiplier. Part of the initial increase in disposable income caused by the decrease in income tax will be saved rather than spent.
The central bank buys $6,000 worth of bonds in the open market from Brian, who deposits the proceeds in his checking account at NDA Bank. The banking system has limited reserves, and the required reserve ratio is 20%.
What is the dollar value of the maximum amount of new loans NDA Bank can initially make as a result of Brian’s deposit? Explain.
Based on the central bank’s open-market purchase of bonds, calculate the maximum amount by which the money supply can change throughout the banking system.
The maximum amount of new loans NDA bank can initially make is $4,800, as the bank can lend out its excess reserves, which are $4,800.
The money supply can increase throughout the banking system as $30,000.
The economy of Beta is in a recession.
The banking system in Beta has ample reserves. Identify a combination of fiscal and monetary policy actions that would be most effective in restoring full employment in the short run.
Now assume that instead of taking action to address the recession, policymakers in Beta decide to take no policy action and instead wait for the long-run adjustment process to return the economy to full employment. As the economy of Beta adjusts from a recession to full employment in the long run, will the short-run Phillips curve shift to the left, shift to the right, or remain unchanged? Explain.
An expansionary fiscal policy action such as an increase in government spending, an increase in transfers, or a decrease in taxes.
An expansionary monetary policy action such as a decrease in administered interest rates or a decrease in interest on reserves.
The short-run Phillips curve will shift to the left in the long run and nominal wages, input prices, and/or inflationary expectations will decrease in the long run.
DOUBLE POINTS
Suppose that Mexico decreases its tariff rates on all of its imports of automobiles from abroad.
Will each of the following groups benefit from the decrease in the tariff rate?
Mexican consumers
Mexican automobile manufacturers. Explain.
How would the decrease in the tariff rates affect each of the following in Mexico?
Current account balance. Explain.
Capital account balance
Mexican consumers will benefit.
Mexican automobile manufacturers will not benefit. Reducing tariffs will cause the domestic price of automobiles to fall in Mexico, lowering the production of cars in Mexico.
The current account will move toward a deficit, as the reduction in tariff increases imports relative to exports.
The capital account will move toward a surplus.
Assume wheat farmers in Country X sold their entire crop of wheat to domestic wheat millers, who sold it to domestic bakeries. If the value of wheat farmers’ sales is $10 million, the value of wheat millers’ sales is $25 million, and the value of bakeries’ sales is $65 million, by how much would Country X's nominal GDP change as a result of this transaction? Explain.
The response explains that that the $10 million value of wheat produced was already included in the value of final sales of the millers and the $15 million value of wheat milling was already included in the value of final sales of the bakeries, which is $65 million.
Vander’s economy is in short-run equilibrium with an inflationary gap of $360 billion.
Assume the government takes no policy. What will happen to the actual rate of unemployment in the long run? Explain.
The actual rate of unemployment will increase. Inflationary expectations, nominal wages, and input prices will increase, and the short-run aggregate supply curve will shift to the left until real output decreases to potential (full-employment) output and the unemployment rate increases to the natural rate of unemployment.
Assume that a bank receives a cash deposit of $9,000 from a customer. What is the immediate impact of this transaction on the money supply? Explain.
Now assume that the government increases spending by $9,000, which is financed by a sale of bonds to the central bank.
What will happen to the money supply?
Explain what will happen to the money demand.
There is no impact, as the money was already part of the money supply, so there is no change to MS.
The selling of bonds to the central bank will increase the money supply. This increase will shift the aggregate demand curve to the right, increasing output and income in the economy, and increasing the demand for money.
Assume that the government of Country X, which had a balanced budget, now increases its spending while holding taxes constant. Assume that the government funds the increase in spending with increased borrowing.
What will be the impact of this policy action on the government’s budget balance?
How will private-sector interest-sensitive expenditures be affected?
What will be the impact on the long-run growth rate of the economy? Explain.
There will be a budget deficit.
The higher real interest rate will reduce consumption and investment spending (crowds out private spending).
The growth rate will decrease/the economy will grow at a reduced growth rate, because there will be less capital formation or less investment will slow down the growth of the capital stock.
How does an increase in Japan’s government budget deficit affect the real interest rate in the short run in Japan? Explain.
How does the change in interest rates affect the supply of euros in the foreign exchange market between yen to euros? How will this affect the yen price of the euro?
To reverse the change in the yen price of the euro identified, should the European Central Bank buy or sell euros in the foreign exchange market?
The real interest rate in Japan will increase in the short run because the supply of loanable funds will decrease or the demand for loanable funds will increase.
The supply curve for euros shifts to the right and the yen price of the euro decreases.
The European Central Bank should buy euros.