Reference no: EM133202612 , Length: 2 Pages
Assignment:
Short-answer questions (total 10 questions)
Note: You should show your step-by-step answers to the questions below. If only final answers were provided, no marks will be counted for the question.
Question 1. Suppose that in a small open economy with full employment, national saving is 1000, and consumption is C=C(Y-T) where Y= income and T = tax. The investment is given by I = 600 - 20r, where r is the real interest rate in percent, and the world interest rate is 10 percent.
a) Assume that government spending decreases by 100. What are the levels of investment, trade balance and net capita outflow after the decrease in government spending? Explain your answers.
b) Assume that government spending decreases by 100 and at the same time, the world interest rate increases due to a shock in the world capital market.
Use the long-run model of a small open economy (that we studied in our class) to graphically illustrate and explain in words the impact of the decrease in government spending when the world interest rate is rising on the exchange rate and the trade balance. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the new long-run equilibrium values.
Question 2. Suppose that in order to promote productivity, the Government of Canada and the Bank of Canada work together to increase the investment level in the economy. However, both the policy makers want to keep the national output constant to avoid an overheating of the economy. Use an IS-LM model and figures to illustrate what monetary policy and fiscal policy could achieve this goal? Explain your answers.
Question 3. Assume that the economic returns (for example, interest payments) of holding other assets (such as bonds) decrease significantly, and then holding money becomes more attractive. Assume that money supply is held constant. Use the aggregate demand-aggregate supply model to illustrate graphically the impact in the short run and the long run of this change. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; v. the short-run equilibrium values; and vi. the long-ru equilibrium values. State in words what happens to prices and output in the short run and the long run.
Question 4. Assume that a closed economy is characterized by the following equations:
Consumption: C = 100 + (2 / 3) (Y - T)
Tax: T = 600
Government spending: G = 500
Investment: I = 800 - (50 / 3) r
Ms / P = Md / P = 0.5Y - 50r
where Ms = money supply, Md = money demand, r=interest rate, Y= aggregate income, and P=price level.
a. Write the numerical IS curve for the economy.
b. Write the numerical LM curve for this economy.
c. Solve for the equilibrium values of Y, I, C and r, assuming P = 2.0 and M =1,200.
d. Assuming M=1,200, derive an equation for the aggregate demand curve in this economy.
Question 5. Suppose a small open economy has the following money demand function: M/P = L (r, Y-T), where r is the interest rate and (Y-T) is the disposable income. Please illustrate graphically the short-run impact of a tax cut on the exchange rate and level of output in the small open economy under both fixed and floating exchange rate systems. Be sure to label: i. the axes, ii. the curves, iii. the initial equilibrium levels, iv. the direction the curves shift, and v. the new short-run equilibrium.
Question 6. Suppose that the income level in a closed economy falls during a recession. Assume that at the same time, the central bank in the economy significantly increases its level of the open market purchase.
a. Use a model of money market (we studied in the class) and figures to illustrate the short-run impact of the income decrease and the increase in the open market purchase on the equilibrium interest rate. Explain your answer.
b. Use a close economy model of the goods market (we studied in the class) and figures to illustrate the short-run impact of the change of the equilibrium interest rate (due to the income decrease and the increase in the open market purchase in a.) on the output in the economy.
Question 7. Suppose that the government of a small open economy with perfect capital mobility wants to establish a "stronger" currency by moving its exchange rate higher. Suggest both an appropriate monetary policy adjustment and an appropriate fiscal policy adjustment that would allow the economy to move to a higher exchange rate.
What are the consequences of these adjustments on domestic output and net exports?
Please illustrate and explain your answers graphically. Be sure to label: i. the axes, ii. the curves, iii. the initial equilibrium levels, iv. the direction the curves shift, and v. the new short-run equilibrium.
Question 8. Assume that two countries are exactly alike in every respect except that population grows at a faster rate in country A than in country B.
a) Which country will have the higher level of output per worker in the steady state? Which country will have the higher level of capital per worker in the steady state? Illustrate graphically and explain you answer.
b) Which country will have the faster rate of growth of output per worker in the steady state? Explain your answer briefly.
Question 9. Suppose a closed economy is in recession and the economy is initially in a short-run equilibrium at a level of output below the natural rate.
a) If no policy action is taken, use the IS-LM model to graphically illustrate how the economy will adjust in the long-run.
b) If a fiscal policy is used to return the economy to the natural rate of output, use the IS-LM model to graphically illustrate the long-run equilibrium. What fiscal policy can be used?
c) Explain how investment, the interest rate, and the price level differ in the new long-run equilibrium in the two cases above (a and b).
Question 10. Suppose that in an economy without population growth or technological progress, the production function is: Y = K0.2L0.8, where Y is output, K is capital stock and L is the labour force.
a. Derive steady-state capital stock per worker, steady-state output per worker, and steady-state consumption per worker as a function of the saving rate and the depreciation rate.
b. Now assume that the depreciation rate is 5% per year. What level of capital stock per worker and saving rate maximize consumption per workers?