Download ECON 509 Homework over Chapter 5

ECON 509 Homework over Chapter 5
Due: 3/05/04
Name: Rolf Butz, Dickinson
This assignment covers the chapter 5 material. It is not do until Saturday so that you can
ask questions in class.
Multiple Choice @ 1 point each
1. The Keynesian AS-curve differs from the classical AS-curve, since Keynes
A) thought that labor markets worked smoothly to always establish full employment
B) thought that nominal wages were flexible even when there was unemployment
C) thought that nominal wages were rigid even when there was unemployment
D) described the AS-curve as completely vertical
E) assumed that firms tried to exploit the work force by paying them substandard wages
2. Given the Keynesian AS-curve, expansionary monetary policy will
A) increase the level of output but leave the price level unchanged
B) increase the price level but leave the level of output unchanged
C) increase both the level of output and the price level
D) leave the level of output and the price level unchanged
E) increase the level of output but decrease the price level
3. In the Keynesian supply curve case, a fiscal expansion will
A) have no impact on equilibrium income or prices
B) increase prices but have no impact on equilibrium income
C) increase prices more than income
D) increase income more than prices
E) increase equilibrium income but have no impact on prices
4. Which of the following is NOT reflected in a shift of the AD-curve?
A) a change in real money balances due to a change in the price level
B) a change in real money balances due to a change in nominal money supply
C) a change in government transfer payments
D) a change in the confidence of consumers and businesses
E) all of the above will shift the AD-curve
5. A shift of the AD-curve to the right could be caused by
A) a decrease in taxes
B) a decrease in government transfer payments
C) an increase in money demand
D) a decrease in defense spending
E) both A) and C)
6. To maintain a fixed level of aggregate demand, the Fed would have to respond to a tax
increase by
A) increasing reserve requirements
B) increasing the discount rate
C) buying bonds in the open market
D) selling bonds in the open market
E) urging banks to ration credit
7. Expansionary fiscal policy is very effective in significantly increasing the level of output
A) if the AS-curve is totally price inelastic
B) in the classical case
Rolf Butz, Dickinson, ECON 509, Spring 2004, Professor Owens
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C) if the economy is close to full employment
D) if the economy is in a recession
E) both A) and D)
8. Cutting income tax rates will cause
A) a large shift in the AD-curve but a small shift in the AS-curve
B) a small shift in the AD-curve but a large shift in the AS-curve
C) a large increase in output resulting in a large increase in tax revenues
D) a budget deficit so large that income growth is no longer possible
E) both B) and C)
9. As nominal money supply is steadily increased and the long-run AS-curve shifts to the right
over time, we realize that
A) the price level continuously rises since shifts in the AD-curve are always larger than
shifts in the AS-curve
B) the price level stays the same, while output continuously increases
C) the price level increases or decreases depending on the respective shifts in the
AD-curve and the AS-curve, but the level of output is essentially determined by
the shifts in the AS-curve
D) we will experience a substantial increase in inflation with very little increase in
output
E) none of the above
10. In a normal AD-AS diagram with an upward-sloping AS-curve, an increase in money supply will
A) increase output and the price level but not affect the interest rate
B) increase output, the price level, and the interest rate
C) increase output and the price level but lower the interest rate
D) decrease the interest rate, increase the price level, but leave output unchanged
E) increase the price level but leave output and the interest rate unchanged
Rolf Butz, Dickinson, ECON 509, Spring 2004, Professor Owens
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Essay/Graphical section
1.
a. Describe an action that might be taken by the Fed if the economy is experiencing an inflationary
gap. Include graphs. (2 points)
CPI
LAS
SAS
A
P
C + I + G + (NX)
PN
AD1
MS
R
S
I
C
AD
AD
YN
RGDP
YA
AD – Aggregate Demand
LAS – Long-term Aggregate Supply
SAS – Short-term Aggregate Supply
CPI – Consumer Price Index
PN – Price natural
PA – Price actual
PE – Price expected
YN – Output natural
YA – Output actual
MS – Monetary Supply
R – Interest Rate
S – Savings
I – Investment
C – Consumption
RGDP – Real GDP
U - Unemployment
Inflationary Gap is caused when aggregate demand exceeds an economy's productive potential, resulting
in rising inflation and a worsening trade situation. Keeping the Inflation in check, the Feds need to affect
the components of Aggregate Demand – such as Consumption, Investment or Net Export – try to slow it
down by decreasing the Monetary supply, which increase upward pressure on Interest rates – making it
more difficult for consumers/firms to consume or invest – which slows economy down – resulting again in
lowering the Aggregate Demand.
b. Describe an action that might be taken by congress and the President if the economy is experiencing an
inflationary gap. Include graphs in your explanation. (2 points)
CPI
LAS
SAS
A
P
PN
AD1
AD
YN
YA
G
T
RGDP
The government can influence the Aggregate Demand to shift to the left by creating fiscal policy that
reduces government spending or increase taxation on households and businesses – which has the same
effect as decreasing the monetary supply in question 1a. This policy will decrease the Government
spending component of Aggregate Demand, thus shifting the curve from AD 1 to AD.
Rolf Butz, Dickinson, ECON 509, Spring 2004, Professor Owens
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c. What would happen to an economy in the long run if it were experiencing an inflationary gap and neither
monetary nor fiscal policy was actively employed. Include graphs in your answer.
(2 points)
e
CPI
SAS1 (P new)
LAS
SAS
N
P
A
e
P> P
A
e
P
P= P
AD1
AD
N
A
Y
Sinc e PA > PE
Y
Workers will renegotiate wages
A
RGDP
W
Prod. Cost
SRAS
N
After self c orrec tion: Y = Y
A
N
U = U
Known as self-correcting mechanism of the classical economy theory – no government intervention is
needed to correct the economy. Changes in wages will be adjusted in the direction of changes in the price
level. This process occurs over a long period of time. As the economy’s actual output exceeds the
expected output and resources grows scarce, companies bid up wages thus increases production cost. This
increase results in a shift of SAS to the left – resulting in a new equilibrium, which has higher prices, zero
unemployment and full output.
Use the following table to answer question 1. (All figures are in billions of U.S. dollars)
Government purchases of goods and services
Depreciation
Gross private domestic investment
Personal income taxes
Personal and business taxes net of transfer payments
Exports
Social Security payments
Consumption expenditures
Imports
Net interest
$240
240
400
140
120
220
30
640
140
100
2. Calculate the GDP for this economy. You must show all work to receive full credit. (3 points)
GDP = C+ I + G + NX  GDP = C + I + G + (EX – IM)  GDP = 640 + 400 + 240 +
(220 – 140 ) = 1360.
Rolf Butz, Dickinson, ECON 509, Spring 2004, Professor Owens
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3a. In 1991 our economy was in a Long-run equilibrium. OPEC raised the price of oil by enforcing a
quota for each of its member nations. Beginning at a long-run equilibrium, graphically show and explain
the effect this event had on our economy in the short-run. Be sure to describe the impact on
unemployment, GDP, and price level. (3 points)
StagFlation
e
SAS1 (P )
LAS
PI
SAS
P1
P0
UA > UN ,
U
P = Misery Index
AD
A
Y
YN
RGDP
OPEC’s forced decreasing quotas increase the overall cost of producing goods, which will in turn shift the
SAS to the left. At this point a new equilibrium with higher Unemployment, higher Prices, also known as
the Misery Index, and overall lower GDP results . This model represents Stagflation.
b.
Now, beginning at your new short-run equilibrium, graphically depict and explain how the economy
will correct back to a long-run equilibrium if the natural adjustment process is allowed to function
(government does not interfere). Be sure to describe the impact on unemployment, GDP, and price
level. (3 points)
LAS
CPI
SAS2
e
SAS1 (P )
SAS
P
A
P
E
P
AD2
AD1
P
OPEC
W
SAS
S
POIL
SRAS
AD
A
Y
N
Y
RGDP
If OPEC eliminates the quota, supply of oil increases decreasing the price of oil, which increases the SAS.
As the economy reaches optimal level the AD line shifts towards the right. As prices increase and wages
increase to match prices, the SAS shifts towards the left – which brings the economy back to the higher
Unemployment level with higher prices. This cycle continues over and over – also labeled as the
Inflationary spiral.
Rolf Butz, Dickinson, ECON 509, Spring 2004, Professor Owens
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