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Homework 4
Economics 503
Foundations of Economic Analysis
Assigned: Week 4
Due: Week 5
1.
Using aggregate demand, short-run aggregate supply and long-run aggregate
supply curves, explain the process by which each of the following economic events will
move the economy from one long-run macroeconomic equilibrium to another. Illustrate
with diagrams. In each case, what are the short-run and long-run effects on the aggregate
price level and aggregate output?
a. There is a decrease in households’ wealth due to a decline in the stock market.
b. The government lowers taxes, leaving households with more disposable income,
with no corresponding reduction in government purchases.
2.
Consider again the case (b) from the above problem, when the government lowers
taxes. Focus on how event (b) will change money market interest rates and the forex rate.
a. Draw a graph of the money market and show what would happen to money
market interest rates after event (1b) if the central bank left the money supply
unchanged. (Hint: After event (1b), GDP will change. How will this change affect
money demand?).
b. Demonstrate the impact of the changes in the interest rate (described in 2.a.) on
the foreign exchange market. Would the spot exchange rate appreciate or
depreciate?
3.
In 2005, a hurricane hit New Orleans, Louisiana, an important transportation and
oil refining center in the USA, one of Hong Kong’s key for the petrochemical industry in
that country. Consider the impact of the recent hurricanes that devastated that city as a
temporary supply shock for the USA.
a. Discuss briefly, using one graph, the outcomes that we would have been likely
to see in terms of goods markets in the USA as a result of this negative
business cycle shock.
b. Analysts are also worried that the natural disaster might have had a negative
impact on consumer confidence. Discuss briefly, using one graph, the
differences in outcomes that we would observe if this demand side effect were
stronger from the outcomes that we would observe if the supply side effects
were dominant.