Download 1. Money and Inflation 2. Classical Dichotomy

Kyunghun Kim
ECN101(SS1, 2014): Homework3
Due in class on 7/21
1. Money and Inflation
Suppose that an economy has a monetary base(B) of $100. The currency-deposit ratio(cr)
and the reserve-deposit ratio(rr) are given by 0.2 and 0.4, respectively.
a. Compute the money multiplier and money supply in this economy.
b. The Fed wants to increase money supply by open market operations. To double the
money supply, how much should the Fed raise the monetary base?
Assume that output grows at 3% each year and the velocity of money is constant. The real
interest rate is 2%. Answer following questions using the quantity theory of money expressed
in growth rate terms and the Fisher equation.
c. If the money stock grows at 5% each year, what are the inflation rate and the nominal
interest rate?
d. If the Fed increases the growth rate of money from 5% to 7%, what happens to the
inflation rate and the nominal interest rate?
2. Classical Dichotomy
Suppose that the real side of an economy is given as follows.
K = 100, L = 100
Y = K 1/3 L2/3
G = 20, T = 20
C = 20 + 0.5(Y − T )
I = 10 + 100r
The nominal side of this economy is given as follows.
d
M
Demand for real money balance:
= 0.1Y − 50r
P
Money supply: M = 50
P is the overall level of prices and M is money supply set by the Fed.
a. Compute the following real variables: output(Y), real interest rate(r), consumption(C),
and investment(I).
b. Compute the nominal variable which is the overall level of prices(P).
c. If the Fed increases the money supply from 50 to 100, what happens to the real variables: output(Y), real interest rate(r), consumption(C), and investment(I)? What happens to the nominal variable which is the overall level of prices(P)? Does the Classical
Dichotomy hold in this economy?
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Kyunghun Kim
ECN101(SS1, 2014): Homework3
Due in class on 7/21
3. Aggregate Demand: IS-LM Model
Consider an economy described by
C = 0.6(Y − T )
I = 50 − 100r
G = 50, T = 50
where C is consumption, I is investment, G is government spending, and T is tax.
d
M s
The demand for real money balance( M
)
and
supply
of
real
money
balance(
) are
P
P
given by
d
M
= 0.5Y − 250r
P
s
M
= 50
P
The price level is fixed at one(i.e. SRAS is P = 1.).
a. Derive and graph the IS curve.
b. Derive and graph the LM curve.
c. Compute the short-run equilibrium for output, real interest rate, consumption and
investment, and graph it.
d. Suppose that the Fed stimulates the economy by increasing the money supply from 50
to 75. Compute the new short-run equilibrium for output and real interest rate, and
graph it.
4. IS-LM/AS-AD Model
Suppose that the money supply falls permanently in an economy. Assume that the overall
level of prices is fixed in the short run, but the prices are flexible in the long run.
a. Draw the IS-LM/AS-AD model to show long-run and short-run equilibria (Label the
axes and curves, and mark the initial equilibrium as point “ 1 ”, the short-run equilibrium as point “ 2 ”, and the long-run equilibrium as point “ 3 ”.)
b. What happens to output, interest rate, investment, and consumption in the short run?
c. What happens to output, interest rate, investment, and consumption in the long run?
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