Norman

1.[10 total points] AssumethattheU.S.economyiscurrentlyinlong-runequilibrium. (a)[2pts]Drawacorrectlylabeledgraphofaggregatedemandandaggregatesupply andshoweachofthefollowing. (i)Thelong-runaggregatesupplycurve (ii)Thecurrentequilibriumoutput&PL,labeledasYEandPLE,respectively.

PL
PL2 PLE

AD1

LRAS SRAS
E2 E1

AD2

Answer 1(a)(i): 1 pt for correctly labeled graph with downward-sloping AD, upward-sloping SRAS, PLE and YE. (ii) 1 pt for showing a vertical LRAS at YE.

YE YI Real GDP

(b)[2pts]Assumethatthegovernmentincreasesspendingonnationaldefensewithout raisingtaxes. (i)Onyourgraphinpart(a),showhowthegovernmentactionaffectsAD. (ii)Howwillthisgovernmentactionaffecttheunemploymentrateintheshortrun? Explain. Answer: 1. (b) (i) As can be seen on the graph, the increase in G would increase AD to AD2, increasing PL and Y. 1. (b) (II) The increase in AD to AD2 would decrease unemployment in the short run, as the increase in AD would lead to an increase in output & profits, resulting in more workers being hired and therefore the decrease in unemployment.

1.(c)[2pts]Assumethattheeconomyadjuststoanewlong-runequilibriumafterthe increaseingovernmentspending. (i)Howwilltheshort-runaggregatesupplycurveinthenewlong-runequilibrium comparewiththatintheinitiallong-runequilibriuminpart(a)?Explain. (ii)Onyourgraphinpart(a),labelthenewlong-runequilibriumpricelevelasPL2. LRAS

PL
PL2 PLE

SRAS2 SRAS1
E2 E1

AD
YE YI Real GDP

Answer 1.(c)(i): 1 pt for stating that the SRAS will shift to the left because the Increase in AD would result in more inflation so workers will demand higher wages AND showing PL2 correctly in part (a)s graph. 1.(c)(ii) 1 pt for explaining that the actual PL is higher than the expected PL, or wages and commodity prices adjust to higher PL[flexible wages], causing the SRAS curve to shift to the left.

1.(d)[2pts]Inordertofinancetheincreaseingovernmentspendingonnationaldefense frompart(b),thegovernmentborrowsfundsfromthepublic.Usingacorrectly labeledgraphoftheloanablefundsmarket,showtheeffectofthegovernments borrowingontherealinterestrate. (e)[2pts]Giventhechangeintherealinterestrateinpart(d),whatistheimpact oneachofthefollowing? Answer to 1. (d) 1 pt for correctly labeled graph (i)Investment of the LFM. (ii)Economicgrowthrate.Explain. 1 pt for showing a rightward shift of the demand

Real Interest Rate, (%)

D2 LFM D1 S
E2 E1

1 pt for showing a rightward shift of the demand curve resulting in a higher interest rate OR a leftward shift of the supply curve resulting in a higher RIR.

r2 r1

Quantity of Loanable Funds F1 F2 Answer to 1. (e) (i) [1 pt] The higher RIR will result in less investment in tools and machinery. 1. (e) (ii) [1 pt] The decrease in tools and machinery will decrease overall productivity and economic growth [capital stock].

2.[6 total points] Adropincreditcardfeescausespeopletouse creditcardsmoreoftenfortransactionsanddemandlessmoney. (a)[2pts]Usingacorrectlylabeledgraphofthemoneymarket,showhowthenominal interestratewillbeaffected. (b)[1pt]Giventheinterestratechangeinpart(a),whatwillhappentobondpricesin theshortrun?

Nominal Interest Rate

Dm
n1

MS

Answer to 2. (a) The decrease in Dt for money would decrease the Dm curve resulting in a lower NIR and RIR. 2. (b) Bond prices are inverse to the interest rate so bond prices would increase

Answer to 2. (c) The lower IR will increase AD due to more investment and interest n2 sensitive consumption [the lower IR would Dm2 also depreciate the dollar and increase Xn]. All 3 cause an increase in AD & PL in the SR. Quantity of Money 2. (d) Selling bonds would be the OMO as [Money Market] it would decr MS, incr NIR and decr AD & PL.

(c)[2pt]Giventheinterestratechangeinpart(a),whatwillhappentothepricelevel intheshortrun?Explain. (d)[1pt]Identifyanopen-marketoperationtheFedcouldusetokeepthenominalinterest rateconstantatthelevelthatexistedbeforethedropincreditcardfees.Explain.

3.[6 total points] AU.S.firmsells$10millionworthofgoodstoafirmin Argentina,wherethecurrencyisthepeso. (a)[1pt]HowwillthetransactionaboveaffectArgentinasaggregate demand?Explain. (b)[1pt]AssumethattheU.S.currentaccountbalancewithArgentinais initiallyzero.HowwillthetransactionaboveaffecttheUnitedStates current accountbalance?Explain. Answer to 3. (a) The selling of $10 M of U.S. goods to Argentina would decrease Argentinas net exports which would decrease their AD. AD = C+I+G+X-M, when M gets larger, GDP gets smaller. 3. (b) The $10 million increase in net exports would cause a flow of $10 million worth of pesos into the U.S. [recorded as a +$10 million] and would cause a current account balance of ZERO to become a +$10 million surplus account balance.

Price

Peso Price of Dollar

Plookingfor$s $slookingforP E2 P100

P50

D1$

S2$

S1$

Answer to 3. (c) (i): If the U.S. decrease financial investment

in Argentina, the U.S. would decrease their supply of

dollars to Argentina, resulting

Peso
depreciates

E1

in a decrease in demand for the peso. (c) (ii) As shown on the graph,
the dollar would appreciate.

Quantity of Dollars

(d) The cheaper prices in the U.S. will result in more demand for U.S. goods and therefore the dollar, appreciating the dollar and depreciating the peso.

3.(c)[2pt]UsingacorrectlylabeledgraphoftheforeignexchangemarketfortheU.S. dollar,showhowadecreaseintheU.S.financialinvestmentinArgentinaaffectseach. (i)ThesupplyofUnitedStatesdollars (ii)ThevalueoftheUnitedStatesdollarrelativetothepeso (d)[2pt]Supposethattheinflationrateis3%intheU.S.and5%inArgentina. WhatwillhappentothevalueofthepesorelativetotheUnitedStatesdollaras aresultofthedifferenceininflationrates? Explain.

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