December 16, 2008, immediately following a regular meeting, the Federal Open Market Committee (FOMC) announced that it would lower its target for the federal funds rate to between 0 and 0.25 percent, the tenth reduction in 15 months. In cutting the target rate, the FOMC stated that "The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time." True to its words, the FOMC kept the rate near zero for at least the next two years. As you know by now, the federal funds rate is the interest rate banks charge one another for overnight lending of reserves at the Fed. Because lowering the rate reduces the cost of covering any reserve shortfall, banks are more willing to lend to the public. To execute this monetary policy, the FOMC authorized the New York Fed to make open-market purchases to increase bank reserves until the federal funds rate fell to the target level. For four decades, the Fed has refl ected its monetary policy in this interest rate. There are many interest rates in the economy?for credit cards, new cars, mortgages, home equity loans, personal loans, business loans, and more. Why focus on such an obscure rate? First, by changing bank reserves through open-market operations, the Fed has a direct lever on the federal funds rate, so the Fed's grip on this rate is tighter than on any other market rate. Second, the federal funds rate serves as a benchmark for determining other short-term interest rates in the economy. For example, after the Fed announces a rate change, major banks around the country usually change by the same amount their prime interest rate?the interest rate banks charge their best corporate customers. The federal funds rate affects monetary and fi nancial conditions, which in turn affect employment, aggregate output, and the price level. The Fed uses the federal funds rate to pursue its primary goals of price stability and sustainable economic growth. The chart below shows the federal funds rate since early 1996. As a lesson in monetary policy, let's walk through the Fed's rationale. Between early 1996 and late 1998, the economy grew nicely with low infl ation, so the FOMC stabilized the rate in a range of 5.25 percent to 5.5 percent. But in late 1998, a Russian default on its bonds and the near collapse of a U.S. fi nancial institution created economic havoc, prompting the FOMC to drop the target rate to 4.75 percent. By the summer of 1999, those fears abated, and instead the FOMC became concerned that robust economic growth would trigger higher infl ation. In a series of steps, the federal funds target was raised from 4.75 percent to 6.5 percent. The FOMC announced at the time that the moves "should markedly diminish the risk of rising infl ation going forward." Some critics argued that the Fed's rate hikes contributed to the 2001 recession. In 2001, concerns about waning consumer confi dence, weaker capital spending, and the 9/11 terrorist attacks prompted the FOMC to reverse course. Between the beginning of 2001 and mid-2003, the FOMC cut the rate from 6.5 percent to 1.0 percent, refl ecting the most concentrated monetary stimulus ever. The rate remained at 1.0 percent for a year. Some economists criticized the Fed for keeping rates too low too long. They charged that this "easy money" policy overstimulated the housing sector, encouraging some to buy homes they really couldn't afford. These home purchases, critics argued, infl ated the bubble in housing prices and sowed the seeds for mortgate defaults that hit years later. Anyway, after leaving the rate at 1.0 percent for a year, the FOMC began worrying again about infl ationary pressure. Between June 2004 and June 2006, the target federal funds rate was increased from 1.0 percent to 5.25 percent in 17 steps. The FOMC then hit the pause buttton, leaving the rate at 5.25 percent for more than a year. This takes us up to September 2007, when troubles in the housing sector, a rising mortgage default rate, and a softening economy prompted the fi rst in what was expected to be a series of federal funds rate cuts. After 10 cuts over 15 months, the target rate in December 2008 stood between 0 and 0.25 percent, the lowest in history. Recent Ups and Downs in the Federal Funds Rate Since the early 1990s, the Fed has pursued monetary policy primarily through changes in the federal funds rate, the rate that banks charge one another for borrowing and lending excess reserves overnight. SOURCE: Based on monthly averages from the Federal Reserve Bank. Percent 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0 1996 1997 1998 1999 2000 2001 Rate increased to slow red-hot economy Rate increases to head off inflation Rate cuts to limit impact of mortgage defaults on economy and respond to recession Rate cuts to combat recession Global financial crisis prompts rate cuts 2002 2003 2004 2005 2006 2007 2008 2009 2010 16 26692_CS_01-42.indd 32 6692_CS_01-42.indd 32 11/11/11 6:13 PM 1/11/11 6:13 PM Over the years, the Fed has tried to signal its intentions more clearly to fi nancial markets?to become more transparent. In 1995, the FOMC began announcing immediately after each meeting its target for the federal funds rate. Since 2000, the post-meeting statement also included the probable "bias" of policy in the near term?that is, whether or not its current level or direction of interest rate changes would continue. And in 2005, the FOMC began releasing the minutes three weeks after each meeting. By generating such concrete news, FOMC meetings became widely followed media events. If the situation is serious enough, the FOMC may act between regular meetings, and this has a more dramatic impact, particularly on the stock market. The Fed held six unscheduled meetings in 2008. Still, in announcing rate changes, the FOMC must be careful not to appear too troubled about the economy, because those fears could harm business and consumer confi dence further. Also, the FOMC must avoid overdoing rate cuts. As one member of the Board of Governors warned, the FOMC must not cut the rate so much that it "ends up adding to price pressure as the growth strengthens." Thus, the FOMC performs a delicate balancing act in pursuing its main goals of price stability and sustainable economic growth. SOURCES: Sewell Chan, "Fed Study Suggests Rates Will Stay at Record Lows Until 2012," New York Times, 14 June 2010; Michael Derby, "Most Primary Dealers Agree Fed Rate Increases Won't Come Soon," Wall Street Journal, 3 June 2010; and "FOMC Statement on Interest Rates," "Minutes of the Federal Open Market Committee," and "Federal Open Market Committee Transcripts" for various meetings. Find the latest FOMC statements, minutes, and transcripts at http://www.federalreserve.gov/monetarypolicy/fomc.htm. QUESTION 1. Why has the Federal Reserve chosen to focus on the federal funds rate rather than some other interest rate as a tool of monetary policy?.

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(1)(a) A company in a competitive market with a cost function C(q) = 100 + 10q- q^2 + (1/3) q^3 has learned that it will now have to face a specific tax of t = $10 (per unit). This specific tax means that for every unit of output the firm sells it has to pay a tax of t dollars. If the firm sells q units, it pays a total tax of qt. (i) What is the firm's cost function including the tax? (ii) What is this firm's short-run profit-maximizing output if the market price is p? (Hint: the solution has to be expressed as a function of p and has to be defined for values that make economic sense, e.g. only positive quantities.) (b) You are given the following information about a particular perfectly competitive industry with identical firms: Market demand: QP = 6500 - 100P Market supply: Q = 1200P Firm total cost function: C(q) = 722 + 9 200 (i) Find the equilibrium in this industry: market price, market quantity, output supplied by each firm, the profit earned by each firm, and the total number of firms. (ii) Would you expect to observe new firms entering this industry in the long run? In what direction would the market equilibrium price and quantity change? (iii) What is the lowest price at which an individual firm would choose to sell output in the long run? What is the firm's profit at this price? (Assume that the short and long run cost curves are the same) (iv) What is the lowest price at which a firm would sell output in the short run? Why? What is the firm's profit at this price?25. A firm is renting machines at pot and paying worken w = $4. With the firm parent input mis, the marginal product of capital in 12 and the marginal product of labor is IS, Is this firm currently using the optimal mix of input? If not, explain what the firm needs to do. a. Yes, optimizing Not optimizing Hire more workers and we lew capital. c. Not optimizing Fire workers and use more capital. Us the following information to answer the new too questions: Widgets Inc. can live workers at $40 per day and can rent a unit of equipment for $10 pa din, Cunealy Widgets Inc. spends 12010 per day on inputs Draw an worcod curse below for Widgets Inc. spending $300. he What is the slope of the baccal curve? C. 17. If Widget lic. hues 4 warken and rents 4 pieces of cqupment, form the marginal product of labor - 20 and they marginal product of capital = 10. Given this information, is Widgets Inc. optimising" If not then what should they do? Optimizing Widget Inc. should not ching mything be Hire more workers and we lew capital Fire workers and up more capital 28. The opportunity col of producing a bicycle weber to & The ad-l -pocket payments made to produce the bicycle b, The vala of the goods that some given up to produce the bicycle L. The bigche's mould price d The marginal cost of the lad baycle produced The average of cost of producing a bicycle 29. Suppose that Pepsi Bottling Conquay hai s MP - 30 & MP - 40 and the renal rate on capitol is $IQ. If the Level of production is cumendy efficient. then the wage rate for Pepsi Hosing Company must be 1. A finn's marginal col is defined in The ratio of total paid to bilal output The mio of jobaboutpul to total cost The addimal com of producing doc more unit of gulpul d The cost of podmiss the Apical mail