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Principles of Economics Principles of MacroEconomics 101

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					Principles of MacroEconomics: 101
Problem Set #2
Due Date: October 6th                                                                Name: ________________



   1. Explain each of the following: (a) the wealth effect, (b) interest rate effect, and (c) international trade
      effect.




   2. Explain what happens to the aggregate demand in each of the following cases: (a) The interest rate
      rises; (b) Wealth falls; (c) The dollar depreciates relative to foreign currencies; (d) Households expect
      lower prices in the future; (e) Business taxes rise.




   3. Explain what is likely to happen to U.S. export and import spending as a result of the dollar depreciating
      in value.




   4. How will a change in the money supply affect aggregate demand?




   5. Explain how each of the following can affect short-run aggregate supply: (a) An increase in wage rates;
      (b) A beneficial supply shock; (c) An increase in the productivity of labor; (d) A decrease in the price of
      a nonlabor resource (such as oil).




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6. A change in the price level affects which of the following? (a) The quantity demanded of Real GDP; (b)
   Aggregate demand; (c) Short-run aggregate supply; (d) The quantity supplied of Real GDP.




7. In the short run, what is the impact on the price level and Real GDP of each of the following: (a) An
   increase in consumption brought about by a decrease in interest rates; (b) A decrease in exports
   brought about by an appreciation of the dollar; (c) A rise in wage rates; (d) A beneficial supply shock;
   (e) An adverse supply shock; (f) A decline in productivity.




8. What is the difference between short-run equilibrium and long-run equilibrium?




9. An economist is sitting in the Oval Office of the White House, across the desk from the president of the
   United States. The president asks, “How does the unemployment rate look for the next quarter?” The
   economist answers, “It’s not good. I don’t think Real GDP is going to be as high as we initially thought.
   The problem seems to be foreign income—it’s just not growing at the rate we thought it was going to
   grow.” How can foreign income affect U.S. unemployment?




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10. Diagrammatically represent the effect on the price level and Real GDP in the short-run of each of the
    following: (a) an increase in wealth, (b) an increase in wage rates, and (c) an increase in labor
    productivity.




11. Directions: For each question, draw an economy in equilibrium, labeling the initial equilibrium price level
    and equilibrium quantity of Real GDP. Then shift the appropriate curve and label the new equilibrium
    price and equilibrium quantity. Next, fill in the blanks to describe what happened.


a. There is a decrease in wealth.




The price level will     and Real GDP will       .



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b. There is a decrease in wage rates.




The price level will     and Real GDP will        .


c. Consumers start to expect lower future incomes.




The price level will     and Real GDP will        .


d. There is a decrease in productivity.




The price level will    and Real GDP will     .




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e. Consumers start to expect higher future prices.




The price level will     and Real GDP will         .


f. There is a decrease in personal income taxes.




The price level will     and Real GDP will         .


g. There is an adverse supply shock.




The price level will     and Real GDP will         .




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h. There is an increase in foreign real national income.




The price level will      and Real GDP will        .


i. What will happen if there is a decrease in interest rates at the same time that there is an increase in wage
rates, and AD shifts by more than SRAS shifts?




The price level will      and Real GDP will        .



j. What will happen if there is a decrease in the value of the U.S. dollar at the same time that there is a
decrease in prices of nonlabor inputs, and AD and SRAS shift by the same amounts?




The price level will          and Real GDP will            .


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12. What is the classical economics position with respect to (a) wages, (b) prices, and (c) interest rates?




13. What is the explanation for why investment falls as the interest rate rises?




14. According to classical economists, does an increase in saving shift the AD curve to the left? Explain
    your answer.




15. Describe the relationship of the (actual) unemployment rate to the natural unemployment rate in each of
    the following economic states: (a) a recessionary gap, (b) an inflationary gap, and (c) long-run
    equilibrium.




16. Diagrammatically represent an economy in (a) an inflationary gap, (b) a recessionary gap, and (c) long-
    run equilibrium.




17. According to economists who believe in a self-regulating economy, what happens—step-by-step—
    when the economy is in a recessionary gap? What happens when the economy is in an inflationary
    gap?




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18. Suppose the economy is self-regulating, the price level is 132, the quantity demanded of Real GDP is
    $4 trillion, the quantity supplied of Real GDP in the short run is $3.9 trillion, and the quantity supplied of
    Real GDP in the long run is $4.3 trillion. Is the economy in short-run equilibrium? Will the price level in
    long-run equilibrium be greater than, less than, or equal to 132? Explain your answers.




19. Suppose the economy is self-regulating, the price level is 110, the quantity demanded of Real GDP is
    $4 trillion, the quantity supplied of Real GDP in the short run is $4.9 trillion, and the quantity supplied of
    Real GDP in the long run is $4.1 trillion. Is the economy in short-run equilibrium? Will the price level in
    long-run equilibrium be greater than, less than, or equal to 110? Explain your answers.




20. Jim says, “I think it’s a little like when you have a cold or the flu. You don’t need to see a doctor. In time
    your body heals itself. That’s sort of the way the economy works too. We don’t really need government
    coming to our rescue every time the economy gets a cold.” According to Jim, how does the economy
    work?




21. How is Keynes’s position different from the classical position with respect to wages, prices, and Say’s
    law?




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22. Give two reasons why wage rates may not fall.




23. How was Keynes’s position different from the classical position with respect to saving and investment?




24. Given the Keynesian consumption function, how would a cut in income tax rates affect consumption?
    Explain your answer.




25. Explain the multiplier process.




26. What is the relationship between the MPC and the multiplier?




27. According to Keynes, can an increase in saving shift the AD curve to the left? Explain your answer.




28. What factors will shift the AD curve in the simple Keynesian model?




29. According to Keynes, can the private sector always remove the economy from a recessionary gap?
    Explain your answer.




30. Compute the multiplier in each of the following cases: (a) MPC = 0.60; (b) MPC = 0.80; (c) MPC =
    0.50.

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31. What is the difference between government expenditures and government purchases?




32. What is the difference between discretionary fiscal policy and automatic fiscal policy?




33. Why is crowding out an important issue in the debate over the use of fiscal policy?




34. Tax cuts will likely affect aggregate demand and aggregate supply. Does it matter which is affected
    more? Explain in terms of the AD-AS framework.




35. The economy is in a recessionary gap and both Smith and Jones advocate expansionary fiscal policy.
    Does it follow that both Smith and Jones favor so-called big government?




36. Graphically show how fiscal policy works in the ideal case of eliminating a recessionary gap and
    eliminating an inflationary gap:




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37. Graphically illustrate the following:
    (a)    Fiscal policy destabilizes the economy
    (b)    Fiscal policy eliminates an inflationary gap
    (c)    Fiscal policy only partly eliminates a recessionary gap.




38. Money is a means of lowering the transaction costs of making exchanges. Do you agree or disagree?
    Explain your answer.




39. The smaller the required reserve ratio the larger the simple deposit multiplier. Do you agree or disagree
    with this statement. Explain your answer.




40. Suppose r = 10 percent and the Fed creates $20,000 in new money that is deposited in someone’s
    checking account in a bank. What is the maximum change in the money supply as a result?




41. The Fed creates $100,000 in new money that is deposited in someone’s checking account in a bank.
    What is the maximum change in the money supply if the required reserve ratio is 5 percent? 10
    percent? 20 percent?




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42. Explain how an open market purchase increases the money supply.




43. Explain how an open market sale decreases the money supply.




44. Explain how a decrease in the required reserve ratio increases the money supply.




45. Suppose you read in the newspaper that all last week the Fed conducted open market purchases and
    that on Tuesday of last week it lowered the discount rate. What would you say the Fed was trying to
    do?




46. The Fed has announced a new lower target for the federal funds rate. In other words, it wants the
    federal funds rate to be lower than it currently is. What does setting a lower target for the federal funds
    rate have to do with open market operations?




47. If reserves increase by $2 million and the required reserve ratio is 8 percent, then what is the maximum
    change in checkable deposits?




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48. Complete the following table:

                                               Effect on the Money Supply
            Federal Reserve Action
                                                      (up or down?)
            Lower the discount rate
            Conduct open market purchase
            Lower required reserve ratio
            Raise the discount rate
            Conduct open market sale
            Raise the required reserve ratio




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