Question

1. Assume unemployment is high and is a major problem in the United States.

1. In an effort to get unemployment back to its natural rate, the Federal Reserve enacts an expansionary monetary policy by purchasing $10 million in U.S. Treasury bonds.
   1. If the reserve ratio is 10 percent, what is the maximum increase in money supply that may occur as a result of the Fed’s open market operation?

2. Give one reason why money supply may not increase by the amount given in part (a)(i)?

2. Using a correctly labeled aggregate demand and aggregate supply graph, identify each of the following.

1. The natural rate of output, labeled Y_f.
2. The equilibrium output and price level prior to the Fed policy action, labeled Y₁ and PL₁, respectively.
3. The new equilibrium output and price level after the Fed policy action, labeled Y₂ and PL₂, respectively.
4. Fiscal policymakers also attempt to decrease unemployment by increasing government spending by $50 million. Given a marginal propensity to consume of 0.75, calculate the expected increase in output that will occur due to the increase in government spending.

4. Congress also decides to decrease corporate tax rates. Explain the effect of the tax cut on the following.

1. Private investment. Explain.

2. Long-term economic growth.

5. Due to the now lowered corporate tax rates, foreign firms begin purchasing land in America.

1. Identify the correct sub account of the balance of payments of which this is a credit.

2. Illustrate on a correctly labeled graph of the loanable funds market how this capital inflow will affect real interest rates in the United States.

Answer 1

(a is Increase in money = I x {lo million Reserve Ratio = I x 410 million- & 100 million. 0-10 ij 24 the banks do not loan out the entire amount and keep some excess reserves then money supply may not increase by the amount mentioned about the LRAS AS (b) is Y Ty dritial equilibrium at E. Price KE in Increase in money supply Lenel Level & - - will shift AD curve right wards - ADI to AD and new equilibrium occurs at froint E. in OG= 950 million MP C = 0.75 Oy= I x os= L x 450 million = $200 million I-MPC (d) ☺ Tax Cut will increase rate of interest in the economy which will reduce private Investment. AD Y YfH. with the fall in from Rest of the (i) long term economic growth falls private Investment . e | Under capital accant, Capital Inflow world will be credited. iij capital inflow will shift demand curve right ward and this it increases real. Real - interest rate in loanable funds market. - u Int il rate 1 - ng Irnest ment