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TA Section 3, ECN 1B Summer 2015
Ilhyun Cho
University of California, Davis
[email protected]
July 9, 2015
Ilhyun Cho (UC Davis)
July 9, 2015
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Q1
Inflation that is — than expected benefits —; inflation that is — than
expected benefits —.
1
higher; creditors; lower; debtors
2
higher; creditors; higher; debtors
3
lower; debtors; lower; creditors
4
higher; debtors; lower; creditors
Ilhyun Cho (UC Davis)
July 9, 2015
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Q1
Inflation that is — than expected benefits —; inflation that is — than
expected benefits —.
1
higher; creditors; lower; debtors
2
higher; creditors; higher; debtors
3
lower; debtors; lower; creditors
4
higher; debtors; lower; creditors
R =r +i
where,
R: nominal interest rate
r : real interest rate
i: inflation rate
Ilhyun Cho (UC Davis)
July 9, 2015
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Q2
An unanticipated increase in inflation will —
1
hurt debtors.
2
hurt creditors and debtors
3
benefit creditors.
4
benefit debtors.
Ilhyun Cho (UC Davis)
July 9, 2015
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Q2
An unanticipated increase in inflation will —
1
hurt debtors.
2
hurt creditors and debtors
3
benefit creditors.
4
benefit debtors.
R =r +i
where,
R: nominal interest rate
r : real interest rate
i: inflation rate
Ilhyun Cho (UC Davis)
July 9, 2015
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Q3
In The General Theory, Keynes argued that the amount of consumption
undertaken by a household is — related to —.
1
directly; the level of interest rates
2
indirectly; the level of interest rates
3
indirectly; its income
4
directly; its income
Ilhyun Cho (UC Davis)
July 9, 2015
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Q3
In The General Theory, Keynes argued that the amount of consumption
undertaken by a household is — related to —.
1
directly; the level of interest rates
2
indirectly; the level of interest rates
3
indirectly; its income
4
directly; its income
C = a + bY
Ilhyun Cho (UC Davis)
July 9, 2015
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Q4
If C = 100 + .8Y, then S =
Ilhyun Cho (UC Davis)
July 9, 2015
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Q4
If C = 100 + .8Y, then S = −100 + .2Y
Y =C +S
C = a + bY
⇒ S = Y − C = Y − a − bY = −a + (1 − b)Y
Ilhyun Cho (UC Davis)
July 9, 2015
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Q5
When the planned investment function is fixed, investment — when
income —.
1
increases; does not change
2
does not change; changes
3
increases; increases
4
decreases; does not change
Ilhyun Cho (UC Davis)
July 9, 2015
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Q5
When the planned investment function is fixed, investment — when
income —.
1
increases; does not change
2
does not change; changes
3
increases; increases
4
decreases; does not change
Ilhyun Cho (UC Davis)
July 9, 2015
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Scenario 1 Q7-Q8
Assume that a consumption function is C = 200 + .8Y.
When Y equals $200 billion, then C = $ — billion.
The marginal propensity to save is
Ilhyun Cho (UC Davis)
July 9, 2015
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Scenario 1 Q7-Q8
Assume that a consumption function is C = 200 + .8Y.
When Y equals $200 billion, then C = $ 360 billion.
The marginal propensity to save is 0.2.
Y =C +S
⇒ ∆Y = ∆C + ∆S
∆Y
∆C
∆S
⇒
=
+
∆Y
∆Y
∆Y
⇒ 1 = MPC + MPS
⇒ MPS = 1 − MPC
Ilhyun Cho (UC Davis)
July 9, 2015
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Scenario 2 Q9-Q10
Assume aggregate consumption is C = 400 + .5Y and planned investment
is $125 billion.
If aggregate income is $1000 billion, then the unplanned inventory
change is $ — billion.
If aggregate income is $1000 billion,
1
2
3
4
planned aggregate expenditures are less than income.
unplanned inventory changes are positive.
planned aggregate expenditures intersect the 45 degree line.
planned aggregate expenditures are greater than income.
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July 9, 2015
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Scenario 2 Q9-Q10
Assume aggregate consumption is C = 400 + .5Y and planned investment
is $125 billion.
If aggregate income is $1000 billion, then the unplanned inventory
change is $ -25 billion.
Equilibrium condition : Y = AE = C + I
When Y > C + I (aggregate output > planned expenditure) ⇒ there
is positive unplanned inventory investment.
If aggregate income is $1000 billion,
1
2
3
4
planned aggregate expenditures are less than income.
unplanned inventory changes are positive.
planned aggregate expenditures intersect the 45 degree line.
planned aggregate expenditures are greater than income.
Ilhyun Cho (UC Davis)
July 9, 2015
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Short 4
You are given the following data concerning Atlantis, a legendary country.
C = 200 + 0.9Y
I = 100
Y
3000
3500
4000
4500
5000
Unplanned Inventory
For the different levels of Y, calculate the level of unplanned inventory.
Show the all calculations you used for obtain your answers.
Ilhyun Cho (UC Davis)
July 9, 2015
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Short 4
You are given the following data concerning Atlantis, a legendary country.
C = 200 + 0.9Y
I = 100
Y
3000
3500
4000
4500
5000
Unplanned Inventory
0
50
100
150
200
For the different levels of Y, calculate the level of unplanned inventory.
Show the all calculations you used for obtain your answers.
Ilhyun Cho (UC Davis)
July 9, 2015
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Q11
Assume that C = 100 + .9(Y - T), net taxes are $100 billion, government
purchases are $200 billion, and planned investment is $100 billion. Then
an output of $2,000 —
1
is below the equilibrium level.
2
results in no change in unplanned inventory.
3
is above the equilibrium level.
4
results in a positive change (increase) in unplanned inventory.
Ilhyun Cho (UC Davis)
July 9, 2015
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Q11
Assume that C = 100 + .9(Y - T), net taxes are $100 billion, government
purchases are $200 billion, and planned investment is $100 billion. Then
an output of $2,000 —
1
is below the equilibrium level.
2
results in no change in unplanned inventory.
3
is above the equilibrium level.
4
results in a positive change (increase) in unplanned inventory.
Equilibrium condition : Y = C + I + G
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July 9, 2015
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Q6
A reduction in the marginal propensity to consume (MPC) will tend to
cause
1
the AE line to become steeper and a given change in investment to
have a greater effect on output.
2
the AE line to become steeper and a given change in investment to
have a smaller effect on output.
3
the AE line to become flatter and a given change in investment to
have a greater effect on output.
4
the AE line to become flatter and a given change in investment to
have a smaller effect on output.
Ilhyun Cho (UC Davis)
July 9, 2015
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Q6
A reduction in the marginal propensity to consume (MPC) will tend to
cause
1 the AE line to become steeper and a given change in investment to
have a greater effect on output.
2 the AE line to become steeper and a given change in investment to
have a smaller effect on output.
3 the AE line to become flatter and a given change in investment to
have a greater effect on output.
4 the AE line to become flatter and a given change in investment
to have a smaller effect on output.
AE = C + I
where
C = a + bY
and
Multiplier ≡
Ilhyun Cho (UC Davis)
1
1
=
MPS
1 − MPC
July 9, 2015
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Q13
Suppose the MPC = .9 and that policymakers want to increase equilibrium
output by 1000. Given this information, policymakers would have to
increase government spending by —
Ilhyun Cho (UC Davis)
July 9, 2015
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Q13
Suppose the MPC = .9 and that policymakers want to increase equilibrium
output by 1000. Given this information, policymakers would have to
increase government spending by 100.
Multiplier ≡
Ilhyun Cho (UC Davis)
1
1
=
MPS
1 − MPC
July 9, 2015
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Short 1
Suppose the economy can be described as follows:
C = 400 + 0.8Yd
I = 300
G = 400
T = tY = 0.2Y
Yd = Y − T
What is the investment multiplier?
Calculate the equilibrium level of GDP.
If investments increase to 500, what is the change in the level of the
equilibrium Y?
Ilhyun Cho (UC Davis)
July 9, 2015
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Short 1
Suppose the economy can be described as follows:
C = 400 + 0.8Yd
I = 300
G = 400
T = tY = 0.2Y
Yd = Y − T
What is the investment multiplier? 2.78
Calculate the equilibrium level of GDP. 3055.56
If investments increase to 500, what is the change in the level of the
equilibrium Y? 555.56
Ilhyun Cho (UC Davis)
July 9, 2015
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Short 1 Variations : Without government
Suppose the economy can be described as follows:
C = 400 + 0.8Y
I = 300
Calculate the equilibrium level of GDP.
What is the investment multiplier?
Ilhyun Cho (UC Davis)
∆Y
∆I
July 9, 2015
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Short 1 Variations : Without government
Suppose the economy can be described as follows:
C = a + bY
I =c
where a = 400, b = 0.8, c = 300.
Y =C +I
⇒ Y = a + bY + c
⇒ (1 − b)Y = a + c
a+c
a
c
⇒Y =
=
+
1−b
1−b 1−b
Ilhyun Cho (UC Davis)
July 9, 2015
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Short 1 Variations : Without government
Suppose the economy can be described as follows:
C = a + bY
I =c
where a = 400, b = 0.8, c = 300.
Calculate the equilibrium level of GDP.
Y =
400 + 300
= 3500
1 − 0.8
What is the investment multiplier?
∆Y
∆I
1
1
=
=5
1−b
1 − 0.8
Ilhyun Cho (UC Davis)
July 9, 2015
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Short 1 Variations : Without government
Suppose the economy can be described as follows:
C = 400 + 0.8Y
I = 300
Y =
a+c
1−b
What is the investment multiplier?
∆Y
∆I
Alternative way:
As I increase to 400 (increase by 100), the equilibrium level of GDP
increases from 3500 to 400+400
1−0.8 = 4000. Thus, the investment multiplier is
4000−3500
500
400−300 = 100 = 5.
Ilhyun Cho (UC Davis)
July 9, 2015
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Short 1 Variations : Government with lump sum tax
Suppose the economy can be described as follows:
C = 400 + 0.8Yd
I = 300
G = 400
T = 400
Yd = Y − T
Calculate the equilibrium level of GDP.
What is the investment multiplier?
∆Y
∆I
What is the government purchase multiplier?
What is the tax multiplier?
Ilhyun Cho (UC Davis)
∆Y
∆G
∆Y
∆T
July 9, 2015
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Short 1 Variations : Government with lump sum tax
Suppose the economy can be described as follows:
C = a + bYd
I =c
G =d
T =e
Yd = Y − T
where a = 400, b = 0.8, c = 300, d = 400, e = 400
Y =C +I +G
Y = a + b(Y − e) + c + d = a + bY − be + c + d
⇒ (1 − b)Y = a − be + c + d
a − be + c + d
a
−be
c
d
⇒Y =
=
+
+
+
1−b
1−b
1−b
1−b
1−b
Ilhyun Cho (UC Davis)
July 9, 2015
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Short 1 Variations : Government with lump sum tax
a
−be
c
d
+
+
+
1−b 1−b 1−b 1−b
Calculate the equilibrium level of GDP.
400 − 0.8 × 400 + 300 + 400
Y =
= 3900
1 − 0.8
Y =
What is the investment multiplier?
∆Y
∆I
1
=5
1 − 0.8
What is the government purchase multiplier?
∆Y
∆G
1
=5
1 − 0.8
What is the tax multiplier?
∆Y
∆T
−0.8
= −4
1 − 0.8
Ilhyun Cho (UC Davis)
July 9, 2015
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Short 1 Variations : Government with balanced budget
Suppose the economy can be described as follows:
C = 400 + 0.8Yd
I = 300
G =T
Yd = Y − T
What is the investment multiplier?
∆Y
∆I
What is the government purchase multiplier?
Ilhyun Cho (UC Davis)
∆Y
∆G
July 9, 2015
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Short 1 Variations : Government with balanced budget
Suppose the economy can be described as follows:
C = a + bYd
I =c
G =T =d
Yd = Y − T
where a = 400, b = 0.8, c = 300
Y =C +I +G
Y = a + b(Y − d) + c + d = a + bY − bd + c + d
⇒ (1 − b)Y = a − bd + c + d
(1 − b)d
a − bd + c + d
a
c
⇒Y =
=
+
+
1−b
1−b
1−b
1−b
Ilhyun Cho (UC Davis)
July 9, 2015
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Short 1 Variations : Government with balanced budget
Y =
a
(1 − b)d
c
+
+
1−b
1−b
1−b
What is the investment multiplier?
∆Y
∆I
1
=5
1 − 0.8
What is the government purchase multiplier?
∆Y
∆G
1
Ilhyun Cho (UC Davis)
July 9, 2015
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Short 1 Variations : Government with proportionate tax
Suppose the economy can be described as follows:
C = 400 + 0.8Yd
I = 300
G = 400
T = tY = 0.2Y
Yd = Y − T
Calculate the equilibrium level of GDP.
What is the investment multiplier?
∆Y
∆I
What is the government purchase multiplier?
Ilhyun Cho (UC Davis)
∆Y
∆G
July 9, 2015
36 / 64
Short 1 Variations : Government with proportionate tax
Suppose the economy can be described as follows:
C = a + bYd
I =c
G =d
T = tY
Yd = Y − T
where a = 400, b = 0.8, c = 300, d = 400, t = 0.2
Y =C +I +G
Y = a + b(Y − tY ) + c + d = a + b(1 − t)Y + c + d
⇒ (1 − b + bt)Y = a + c + d
a+c +d
a
c
d
⇒Y =
=
+
+
1 − b + bt
1 − b + bt
1 − b + bt
1 − b + bt
Ilhyun Cho (UC Davis)
July 9, 2015
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Short 1 Variations : Government with proportionate tax
Y =
a
c
d
+
+
1 − b + bt
1 − b + bt
1 − b + bt
Calculate the equilibrium level of GDP.
Y =
400 + 300 + 400
= 3055.56
1 − 0.8 + 0.8 × 0.2
What is the investment multiplier?
∆Y
∆I
1
≈ 2.78
1 − 0.8 + 0.8 × 0.2
What is the government purchase multiplier?
∆Y
∆G
1
≈ 2.78
1 − 0.8 + 0.8 × 0.2
Ilhyun Cho (UC Davis)
July 9, 2015
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Take a Break
Suppose the economy can be described as follows:
This time we are incorporating wealth (W ) as a determinant of
consumption.
C = 400 + 0.8Y + 0.02W
I = 300
What is the wealth multiplier?
∆Y
∆W
The answer is 0.1. Can you get it?
Ilhyun Cho (UC Davis)
July 9, 2015
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Take a Break
Suppose the economy can be described as follows:
This time we are incorporating wealth (W ) as a determinant of consumption.
C = a + bY + cW
I =d
where a = 400, b = 0.8, c = 0.02, d = 300.
What is the wealth multiplier?
∆Y
∆W
Y =C +I
⇒ Y = a + bY + cW + d
⇒ (1 − b)Y = a + cW + d
a + cW + d
a
cW
d
⇒Y =
=
+
+
1−b
1−b
1−b
1−b
Thus, wealth multiplier is
Ilhyun Cho (UC Davis)
c
1−b
=
0.02
1−0.8
= 0.1
July 9, 2015
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Q12
The difference between what a government spends and what it collects in
taxes in a given period is called —
1
disposable income
2
the unplanned inventory change
3
the trade deficit or surplus .
4
budget deficit / surplus
Ilhyun Cho (UC Davis)
July 9, 2015
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Q12
The difference between what a government spends
{z
}
|
G
and what
it{zcollects} in taxes in a given period is called —
|
T
1
disposable income
2
the unplanned inventory change
3
the trade deficit or surplus .
4
budget deficit / surplus
G > T ⇒ Budget deficit
G < T ⇒ Budget surplus
G = T ⇒ Balanced budget
Ilhyun Cho (UC Davis)
July 9, 2015
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Q14
Since the end of 1997 through 2000, the U.S. budget —
1
was in deficit.
2
was in surplus.
3
deficit was decreasing as a percentage of GDP.
4
was balanced.
Ilhyun Cho (UC Davis)
July 9, 2015
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Q14
Since the end of 1997 through 2000, the U.S. budget —
1
was in deficit.
2
was in surplus.
3
deficit was decreasing as a percentage of GDP.
4
was balanced.
Ilhyun Cho (UC Davis)
July 9, 2015
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Q14
Ilhyun Cho (UC Davis)
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Q14
Ilhyun Cho (UC Davis)
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Q14
Ilhyun Cho (UC Davis)
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Q20
The budget deficit that would occur if the economy were operating at full
employment is sometimes called —
1
the cyclical deficit.
2
the off-budget deficit.
3
the primary deficit.
4
the structural deficit.
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July 9, 2015
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Q20
The budget deficit that would occur if the economy were operating at full
employment is sometimes called —
1
the cyclical deficit.
2
the off-budget deficit.
3
the primary deficit.
4
the structural deficit.
structural deficit : The deficit that remains at full employment.
cyclical deficit : The deficit that occurs because of a downturn in the
business cycle.
Ilhyun Cho (UC Davis)
July 9, 2015
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Q15
— are used as money and also have an intrinsic value in some other use.
1
Commodity monies
2
Legal tender
3
Token monies
4
Federal Reserve notes
Ilhyun Cho (UC Davis)
July 9, 2015
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Q15
— are used as money and also have an intrinsic value in some other use.
1
Commodity monies
2
Legal tender
3
Token monies
4
Federal Reserve notes
What is money?
A means of payment, or medium of exchange
A store of value
A unit of account
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July 9, 2015
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Q15
Commodity monies are used as money and also have an intrinsic value in
some other use.
Radford (Economica, 1945) described the establishment of commodity
money in P.O.W camps.
“People left their surplus clothing, toilet requisites and food there until
they were sold at a fixed price in cigarettes. Only sales in cigarettes were
accepted there was no barter [...] Of food, the shop carried small stocks
for convenience; the capital was provided by a loan from the bulk store of
Red Cross cigarettes and repaid by a small commission taken on the first
transactions. Thus the cigarette attained its fullest currency status, and
the market was almost completely unified.”
Ilhyun Cho (UC Davis)
July 9, 2015
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Q15
— are used as money and also have an intrinsic value in some other use.
1
Commodity monies
2
Legal tender
3
Token monies
4
Federal Reserve notes
Commodity monies : items used as money that also have intrinsic
value in some other use.
Fiat or token money : items designated as money that are intrinsically
worthless.
Legal tender : Money that a government has required to be accepted
in settlement of debts.
Printed on every Federal Reserve notss in the U.S. is “This note is
legal tender for all debts, public and private.”
Ilhyun Cho (UC Davis)
July 9, 2015
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Q16
Which of the following is included in M2 but NOT included in M1?
1
Other checkable deposits
2
Currency held outside banks
3
Demand deposits
4
Savings accounts
Ilhyun Cho (UC Davis)
July 9, 2015
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Q16
Which of the following is included in M2 but NOT included in M1?
1
Other checkable deposits
2
Currency held outside banks
3
Demand deposits
4
Savings accounts
M1 ≡ currency held outside banks + demand deposits + traveler’s
checks + other checkable deposits
M2 ≡ M1+ savings accounts +money market accounts + other near
monies
Ilhyun Cho (UC Davis)
July 9, 2015
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Q17
A bank has reserves of $40, loans of $110, deposits of $90, and net worth
of $60. Which of the following represents the bank’s total assets?
Ilhyun Cho (UC Davis)
July 9, 2015
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Q17
A bank has reserves of $40, loans of $110, deposits of $90, and net worth
of $60. Which of the following represents the bank’s total assets? 150
Ilhyun Cho (UC Davis)
July 9, 2015
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SCENARIO 3 Q18
Assume there is an economy with a single bank, and the central bank sets
the reserve requirement ratio at 20%. Assume also that the only bank had
no transactions (i.e., no loans, reserves, or deposits) prior to the following
events.
What is money multiplier?
Ilhyun Cho (UC Davis)
July 9, 2015
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SCENARIO 3 Q18
Assume there is an economy with a single bank, and the central bank sets
the reserve requirement ratio at 20%. Assume also that the only bank had
no transactions (i.e., no loans, reserves, or deposits) prior to the following
events.
What is money multiplier? 5.
An increase in bank reserves leads to a greater than one for one increase in
money supply. Then how much?
Money multiplier : the multiple by which deposits can increase for
1
every dollar increase in reserves ≡ required reserve
ratio
Ilhyun Cho (UC Davis)
July 9, 2015
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Q19
The Federal Reserve banking system is comprised of how many district
banks?
Ilhyun Cho (UC Davis)
July 9, 2015
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Q19
The Federal Reserve banking system is comprised of how many district
banks? 12
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July 9, 2015
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Q19
Ilhyun Cho (UC Davis)
July 9, 2015
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Short 2
Suppose the economy can be described as follows:
Using your money supply and money demand diagrams, graphically
illustrate the effects of the following on the equilibrium interest rate. Make
sure you label all axes and curves. And identify the initial and ending
equilibrium.
the Fed conducts an open market sale.
the economy hits a recession, resulting in a lower level of Y.
Ilhyun Cho (UC Davis)
July 9, 2015
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Short 3
Suppose you have a bank with a balance sheet described below:
Assets
Reserves: $30,000,000
Securities: $200,000,000
Loans: $320,000,000
Total: $550,000,000
Liabilities
Deposits: $500,000,000
Net Worth: $50,000,000
Total: $550,000,000
Show the effect of each situation described below on the banks balance sheet. Assume
that the bank is required to keep 6% reserves and holds no excess reserves. Note that
each situation below is not related to the other, and you start your analysis with the
same initial balance sheet, which is depicted above..
The Fed increases the reserve requirement to 8 percent, and the bank still holds no
excess reserves
John, who holds a checking account with the bank, uses money from his checking
account to buy a $10,000,000 bond from the US treasury.
If the bank chooses to hold an excess reserves of 6 percent (and the required
reserve is 6 percent), what is the money multiplier?
What is the change in the money supply if all banks behave as described in part c,
and the Fed conducts an open market purchase of $10,000,000 in bonds?
excess
reserves
actual reserves -required reserves
Ilhyun
Cho (UC≡Davis)
July 9, 2015
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