Download QUEENS COLLEGE, ECONOMICS 101, Final Problem Prof. Dohan

QUEENS COLLEGE, ECONOMICS 101,
Final Problem Prof. Dohan Spring 2007
Last Name (Print)_______________________, First _________________
Last 4 # of Soc Sec. # ___________
MACRO ECONOMIC POLICY FOR UKRANRUS
The current president of Ukranrus, a large emerging industrial economy, wants to have both fullemployment and maintain price stability as soon as possible so his political party is reelected.
The Ukranrus economy has the following characteristics (millions of Ukrans)
YFE = potential output at full employment.
Ya* = the equilibrium level of GDP output. Here the value of the GDP output Ya equals Yd the demand
for that output. If Ya* is less then the potential full employment output YFE, the output will goes toward
Ya* which causes unemployment. If Ya* > YFE then output stops growing at YFE and our attempt to by
more than YFE causes inflation.
Yd (AE in the book) = the components of final demand:Yd = C+I+G+X-M (Id = investment demand
which is also influenced by interest rates and the level of output), C = consumption which depends
mostly Or disposable income (Ydi). G = government spending on goods and services excluding transfer
payments, X1 = exports minus imports.
Ydi = Ya – Tx + TR
Note that Ydi = Ya minus taxes plus transfer payments.
A. The equilibrium output is currently Ya*
= 8,000
B. Full employment level of output
YFE = 7,000
C. Marginal propensity to consume MPC = 0.8
D. Currently, its exports and imports cannot be changed because
of trade agreements with its strong neighbors.
1. Sketch and label the economic conditions
in this economy at the equilibrium output on the graph
to the right.
2._On the graph identify the income gap between full employment level
YFE = 7,000 and the equilibrium level of output which is 8,000.
3. What is the horizontal "income gap ΔYa* between YFE (Full employment output) and Ya* (current
equilibrium output where Ya = Yd) and what does it mean in economic terms.
4. Calculate the regular multiplier showing work and describe in one or two words the major
economic problem in this political campaign.
5. What is the aggregate demand equation (write equation here)______________________.
Show the equation as a graph here.
Hint: (ΔYd = YFE - Ya*)
6. What is the vertical “Aggregate demand gap” ΔYd between Ya and Yd at YFE. It is also called the
“AE gap” or aggregate expenditure gap. Explain what it measures. How did you calculate it? Show
work.
493721893, 6/29/2017 10:59:00 PM ,Michael Dohan
7. VIP: What fiscal or monetary policies do we have to reach full employment with price stability
(FEWPS)?
That is, what variables can we use to shift ΔYd up or down by the required amount so that the income
gap between full employment and aggregate expenditure is closed.
can we use to shift Yd. in the equation and on the graph
on graph to the right. Show and label ΔYd
and ΔYa* and indicate what direction they should move
to reach FEWPS. Show and label the between the origin and the
493721893, 6/29/2017 10:59:00 PM ,Michael Dohan
"i" denotes interest rate.
"I(i)" represents the interest-determined part of
investment (assume no induced investment) in millions of
Ukrans
"Md" represents the speculative or asset demand for
money (we ignore transaction demand) in millions of
Ukrans
The firms and populace of Ukranrus hold all their money
in the bank in the form of checking accounts (called
“demand deposits” by economists) so that the entire
money supply Ms consists of "demand deposits".
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Current Central Bank Policy
 The interest rate “i” is determined by equilibrium in
the money market where Ms =Md
 Ms, the money supply, is currently 520 Ukrans.
 Banks must keep a 12.5% required reserve ratio
against all their demand deposits.
 Banks currently hold no excess reserves because of
the great demand for loans for investment in factories
and new housing.
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i
12
11
10
9
8
7
6
5
4
4
Investment demand is strongly influenced by the interest
rate at which they can borrow to build new factories
Md
| 160
| 240
| 320
| 400
| 440
| 480
| 520
| 660
| 920
| 1000
i
12
11
10
9
8
7
6
5
4
3
I(i) .
| 100
| 200
| 250
| 300
| 350
| 400
| 500
| 700
| 1000
| 2000
NOW assume each of the following policies are
pursued separately (SHOW WORK & EXPLAIN)
5. Because of the current economic crisis, the President lost confidence in his ultra-conservative Minister of Finance
who had conducted a policy of balancing the Federal budget at all times so that Tx = G + Tr. He argued strongly that
no change in Federal fiscal economic policy is necessary because the Ukranrus Federal budget was already balanced.
You now as consultant must now advise the President and the new Minister of Finance whether Federal Ukranrusian
government should continue to strictly balance the budget under the economic conditions or whether it should change
Federal fiscal policy which would result in a deficit or a surplus. What is your advice and why. (2 pt)
493721893, 6/29/2017 10:59:00 PM ,Michael Dohan
1) What changes in government spending could be used at the Federal level to reach FEWPS? Explain why such small
changes might have a large impact on the economy. (Extra Credit: What realistic problems does the President have
in getting quick results from this policy before the election next year?)
4) What changes in taxes are necessary to reach FEWPS? Explain how taxes work to influence Yd and eventually Y*a.
Explain your calculations and answer. EXPLAIN HOW THIS POLICY WOULD BE IMPLEMENTED IN PRACTICE and
what are the economic and political advantages and disadvantages of implementing such a tax policy?
You also advise the President to seek the advice of the well-respected Director of the Ukranrus Central Bank, Dr. Uspanov.
SO HERE IS THE GRAND QUESTION. What monetary policy should Dr. Uspanov ask the Ukranrus Central
Bank pursue to reach FEWPS.?
2) Specifically, what instructions would he give to the Bank’s Department that buy and sells short-term Ukranrusian T-bills.
and what specific changes would you expect in reserves (R), money supply (Ms), interest rates (i), planned investment (Id),
and ΔYa* the equilibrium GDP? EXPLAIN to the president how each step of this new monetary policy would work toward
reaching the goal of FEWPS (Lots of points for this question(
7. In 6, would you buy or sell bonds and how many and why?
8) The Ukranrus Central Bank lends reserves to the bank in the country at an interest rate called the “discount rate”. In 6,
would you lower or raise the discount rate as part of this policy? Why? EXPLAIN
9) Back to politics. Let us assume that Ukranrus has reached FEWPS by using "fiscal policy" leaving the money
supply and interest rates unchanged.. The President wants to appease the electorate by implementing a new policy to
raise labor productivity and real per capita GDP. He proposes investing 200 million Ukrans in new modern plant and
equipment and in research and development this year to make each worker more productive and better paid next year.
What specific changes in taxes and monetary policy would you recommend to achieve this growth without causing a
demand-pull inflation? (4 pt)
Explain and illustrate how the policies
will work using the concepts of
the production possibility frontier (PPF)
and the C+I+G analysis (show and label
the changes.
For the A+ student. If Ukranrus could borrow 200 million Ukran (denominated in Euros) from the World Bank for
implementing this project, how would this opportunity affect the short run and long run economic and political impact
on the economy. What should happen to the PPF.
NOW DO IT AGAIN, BUT ASSUME THAT THE FULL EMPLOYMENT IS 5000, the equilibrium level is 4,500, and
the MPC is 4.
493721893, 6/29/2017 10:59:00 PM ,Michael Dohan