Download 5 lb. Bags of Potatoes 8 6

Problems for Extra Practice
1. Suppose that we have are in a recessionary gap
a. What is the appropriate fiscal policy proposed by liberals and conservatives respectively?
b. What would be the appropriate monetary policy if the Fed wishes to use open market operations?
c. What would be the adjustment process if neither fiscal nor monetary policy is implemented?
d. What are the main pros and cons of using tax changes or changes in G vs. monetary policy vs. doing nothing?
a. liberals-> increase G
conservatives-> lower taxes
b. buy bonds (if used other tools then lower rrr or lower discount rate)
c. wages would fall since there is lots of unemployment. This would cause AS to increase which leads to lower
prices and lower unemployment.
d. fiscal policy and monetary policy operate more quickly than doing nothing but causes inflation whereas doing
nothing causes prices to fall. Using policy has the chance that the govt or fed may mess up and do too much or too
little. Fiscal policy also has the added complication of crowding out and increases the debt.
2. Can you answer #1 if it were instead an inflationary gap or stagflation?
Inflationary gap:
a. liberals-> increase taxes
conservatives -> lower G
b. sell bonds (if use other tools then increase rrr or discount rate)
c. wages rise since very little unemployment. This causes AS to decrease causing higher inflation and higher
unemployment. The economy is much worse off!!!
d. fiscal policy and monetary policy do not cause the inflation that doing nothing does, but it does cause slightly
higher unemployment and runs the risk of doing too much or too little. Fiscal policy allows for the possibility that
some of the debt can be paid off.
Stagflation: see the answers above for recessionary gap if the target is to lower unemployment and the answers for
inflationary gap if the target is to lower inflation. The main thing to remember here is that in order to correct one
problem with policy the other problem is automatically made worse. For the adjustment process if no policy is used
see the answer to 1c.
3. What happens to the national debt if the government runs a budgetary deficit? Would crowding out occur and
how?
Debt increases with a budgetary deficit.
Crowding out is most likely to occur near or past full employment. Crowding out is where government borrowing
leads to higher interest rates which then discourages private investment and consumption.
See the graphs drawn with this in class.
4. I decide to hold $1,000 less in currency and deposit that money into my checking account. If the required reserve
ratio is currently 10%, how much of the $1,000 is required reserves? How much is excess reserves? What happens
is likely to the money supply and why?
Required reserves=100
Excess reserves=1,000-100=900
Potential money creation is 900*1/.1=9,000. So the money supply likely increases by $9,000 as the excess reserves
are loaned out by banks and a multiplied effect occurs.
5. What happens to the interest rate (for a,c,d,e,f), level of unemployment, RGDP, and price level if each of the
following occurs.
(hint, think about which curve shifts and the direction of the shift for each case. You can then graph these to see
what the effect is on unemp, RGDP, and price level. AD will shift if fiscal or monetary policy is used and AS will
shift if nothing is done)
a. the government borrows money so that it can increase government spending
AD increases and interest rates rise, unemployment falls, RGDP rises, and price level rises
b. the government increases the tax rate
AD decreases so unemployment rises, RGDP falls, and price level falls
c. the Fed buys bonds
interest rates fall as the money supply increases. This causes AD to increase so unemployment falls,
RGDP rises, and price level rises
d. the Fed sells bonds
interest rates rise as the money supply lowers. This causes AD to decrease so unemployment rises, RGDP
falls, and price level falls
e. the Fed lowers the required reserve ratio
same as c
f. the Fed raises the required reserve ratio
same as d
g. nothing is done but we are in a recessionary gap
see 1c above
h. nothing is done but we are in an inflationary gap
see 1d above
i. nothing is done but we are experiencing stagflation
see 1c above
6. When would the policies given in a through f be appropriate (inflationary gap or recessionary gap or stagflation)?
a, c,e. recessionary gap or stagflation when the target is to lower unemployment
b, d, f. inflationary gap or stagflation when the target is to lower inflation
7. Explain the process which occurs when the Federal Reserve Sells bonds by filling in the following blanks with
either  or . As the federal reserve sells bonds,
Bank Reserves________________
Loans made __________________
Money Supply ________________
Interest rates _________________
AD _________________________
8. The numbers below illustrate how many units of a good can be produced in one day by one person in each
country if they only produce one type of good.
US
Ireland
5 lb. Bags of Potatoes
8
6
Bushels of Apples
1
2
a.
Which country has a absolute advantage in apples? Ireland
b.
Which country has the absolute advantage in potato production? US
c.
What is the opportunity cost of 1 bag of potatoes in the US? In Ireland?
US: 1/8 apple
d.
What is the opportunity cost of 1 bushel of apples in the US? In Ireland?
US: 8P
e.
IR: 1/3Apple
IR: 3P
Which country has a comparative advantage in apple production?
Ireland since lower opp cost
f.
Which country has a comparative advantage in potato production?
US since lower opp cost
g.
Would these countries be willing to trade? If so, how many bags of potatoes would be traded for one
bushel of apples? Yes: Trade 3-8 bags of potatoes for one bushel of apples
9. The numbers in the following table illustrate how many bushels of a good can be produced in one day
by one person in each country
US
Canada
Tobacco
12
4
Soybeans
4
2
a. Which country has the absolute advantage in tobacco production?
US
b. Which country has the absolute advantage in soybean production?
US
c. What is the opportunity cost of 1 bushel of tobacco in the US? In Canada?
US: 1/3 S
CA: ½ S
d. What is the opportunity cost of 1 bushel of soybeans in the US? In Canada?
US: 3 T
CA: 2T
e. Which country has a comparative advantage in tobacco production?
US since lower opp cost
f. Which country has a comparative advantage in soybean production?
CA since lower opp cost
g. How much tobacco would be traded for one bushel of soybeans?
2-3 T
The table below presents the demand and supply curves for microcomputers in Japan and the US.
10. Price in 1,000s
Qd US
Qs US
Qd Japan
Qs Japan
$1
90
30
50
50
$2
80
35
40
55
$3
70
40
30
60
$4
60
45
20
65
$5
50
50
10
70
$6
40
55
0
75
a. If there is no trade between the US and Japan, what is the equilibrium price and quantity in the
computer market in the US? In Japan?
US: QD=QS at $5 and Q=50, Japan: Qd=Qs at $1 and Q=50
b. If trade is allowed, what will be the equilibrium world market price for computers? Why?
Price World Qd
World Qs
1
140
80
2
120
90
3
100
100
4
80
110
5
60
120
6
40
130
So, eq. price is $3 and world quantity is 100
11. Assume that salt is currently imported from abroad at a market price of 30cents per pound.
a. What happens to the price of imported salt and quantity of imported salt sold if a tariff of 5 cents is
placed on imported salt? Price increases and quantity decreases
Would your answer differ if instead a quota was placed on salt? No, just gains from price increase go
to seller rather than govt.
b. What happens to the price and quantity of domestically produced salt? Why?
Price increases and Q increases because demand for domestically produced salt increases as the price of
foreign salt (a substitute) increases