Explain in details

Problem 10.5. Suppose that the money demand function is: = Y -100. r, where r is the nominal interest rate=real interest rate in percent. Let Y=1000, and M=1000, and P=2. A. Graph the supply and demand for real money balances. B. What is the equilibrium interest rate? C. Assume that the price level is fixed. What happens to the equilibrium interest rate if the supply of money is raised from 1000 to 1200? D. If the central bank wishes to raise the interest rate to 7 percent, what nominal money supply (M) should it choose? Problem 9.1 (modified): Suppose that banks start paying interest on current accounts so that holding money becomes more attractive. Recall that the money stock is the sum of currency and demand deposits, including current accounts. A. How is real money demand affected? What happens to the interest on interest-bearing government bonds? B. What happens to the velocity of money? C. If the central bank keeps the money supply constant, what will happen to output and prices in the short and in the long run? D. Should the central bank keep the central bank constant in response to this change in behavior of banks? Problem 9.2: Suppose that the central bank reduces the nominal money supply by 5 percent. A. What happens to the aggregate demand curve? B. What happens to the level of output and the price level in the short run and in the long run? C. What happens to the real interest rate in the short run and in the long run? (Hint: Use the model of the real interest rate in chapter 3 to see what happens when output changes.) Problem 9.3: Suppose that central bank A cares only about keeping the price level stable, and central bank B cares only about keeping output and employment at their natural levels. Explain how each central bank would respond to each of the following: A. An exogenous decrease in the velocity of money; that is, an increase in Real money demand at given levels of the interest rate and income. B. B. An exogenous increase in the price of oil. 10. THE SIMPLE KEYNESIAN MODEL FOR THE SHORT RUN FOR A CLOSED ECONOMY 1. Use the simple Keynesian Model to predict the impact of a. An increase in government purchases. b. An increase in taxes, C. An equal increase government purchases and taxes. 2. In the simple Keynesian model, assume that the consumption function is given by C =200 + 0.75 (Y - T). Planned investment is 100, government purchases and taxes are both 100. a. Graph planned expenditure as a function of income. b. What is the equilibrium level of income? c. If government purchases increase to 125, what is the new equilibrium income? d. What level of government purchases is needed to achieve an income of 1,600 ? 3. Although our basic version of the simple Keynesian model assumes that taxes Are fixed amount, in many countries (including the United States) taxes depend on income. Let's represent the tax system by writing tax revenue as T = T+t-Y Where T and t are parameters of the tax code. The parameter t is the marginal and proportional tax rate: if income rises by $1, taxes rise by *$1. a. How does this tax system change the way consumption responds to changes in GDP? b. In the simple Keynesian model, how does this tax system alter the government- purchases multiplier? 4. Consider the impact of an increase in thriftiness in the simpel Keynesian model. Suppose the consumption function is C=C+c.(Y-T)LAccording to the Keynesian model in the short run for a closed economy (The IS-LM- model), what happens to the interest rate, income, consumption, and invesnnent under the following circumstances? a. The central banlt increases the money supply. b; The government increases government purchases. C. The government increases taxes d; The government increases government purchases and taxes by equal amounts. 2' Use the Keynesian model in the short Inn for a closed economy {The IS-LM-model) To predict the effects of each of the following shocks on income, the interest rate, consumption and investment. In each case, explain what the central bank should do to keep income at its initial level; a. After the invention of a new high-speed computer chip, many firms decide to upgrade their computer systems. bi A. wave of credit-card frauds increases the frequency with which people make transactions in cash c. A best-seller titled Retire Rich convinces the public to increase the percentage of their income devoted to saving. 3. Consider the economy of I-licltsonia a. The consumption function is given by C: 200+0.T5-(1" -f) The investment function is l=200-25' r Government purchases and taxes are both 100. The money demand function in Hicksonian is: (MIPT' =Y -100:r The money supply M is 1000 and the price level P is 2. c. Find the equilibrium interest rate r and the equilibrium level of income Y' (1. Suppose that government purchases are raised from 100- 150. How much would Y increase if the real interest rate were constant\";. What are the new equilibrium interest rate and level of income? e. Suppose instead that the money supply is raised from 1,000 to 1,200. What are the new equilibrium interest rate and level of income? f. With the initial values for monetary and fiscal policy, suppose that the price level rises from 2 to 4' What happens '2' What are the new equilibrium interest rate and level of income? g. Derive and graph an equation for the aggregate demand curve. What happens to this aggregate demand curve ifscal or monetary policy changes, as in parts (d) and (e)?I 5' Suppose that the government wants to raise investment but keep output constant. In the ISLM model, what mix of monetary and scal policy will achieve this goal? In the early 1980s, the [LS government cut taxes and rana budget decit while the Fed pursued a tight monetary policy. What effect should this policy mix have'}I 6. Use the IS-LM model to describe the short-run and long-run effects of the following changes on national income, the interest rate, the price level, consumption, investment, and real money balances, a. An increase in the money supply. b. An increase in government purchases. c. An increase in taxes. 7. The Fed is considering two alternatives monetary policies: * holding the money supply constant and letting the interest rate adjust, or * adjusting the money supply to hold the interest rate constant. In the IS-LM mode], which policy will better stabilize output under the following conditions? 2. Consider the following changes in the sticky-wage model. a. Suppose that labor contracts specify that the nominal wage be fully indexed for inflation. That is, the nominal wage is to be adjusted to fully compensate for changes in the consumer price index. How does full indexation alter the aggregate supply curve in this model? b. Suppose now that indexation is only partial. That is, for every increase in the CPI, the nominal wage rises, but by a smaller percentage. How does partial indexation alter the aggregate supply curve in this model? 3. Suppose that an economy has the Philips curve * = 1_1 -0.5(u-0.06) a. What is the natural rate of unemployment? b. Graph the short-run and long-run relationships between inflations and unemployment. C. How much cyclical unemployment is necessary to reduce inflation by 5 percentage points? Using Okun's law, compute the sacrifice ratio. d. Inflation is running at 10 percent. The fed (=central bank in the US)wants to reduce it to 5 percent. Give two scenarios that will achieve that goal. 4. According to the rational-expectations approach, if everyone believes that policymakers are committed to reducing inflation, the cost of reducing inflation-the sacrifice ratio-will be lower than if the public is sceptical about the policymakers' intentions. Why might this be true? How might credibility be achieved? 5. Assume that people have rational expectations and that the economy id described by the sticky-wage or sticky-price model. Explain why each of the following propositions is true: Only unanticipated changes in the money supply affects real GDP. Changes in the money supply that were anticipated when wages and prices were set do not have any real effects. b. If the Fed chooses the money supply at the same time as people are setting wages and prices, so that everyone has the same information about the state of the economy, then monetary policy cannot be used systematically to stabilized output. Hence, a policy of keeping the money supply constant will have the same real effects as a policy of adjusting the money supply in response to the state of economy. ( This is called the policy irrelevance proposition.) C. If the Fed sets the money supply well after people have set wages and prices, so the fed has collected more information about the state of economy, then monetary policy can be used systematically to stabilized output. 6. Suppose that an economy has the Philips curve It = _, -0.5(u-u") and that the natural rate of unemployment is given by an average of the past two years' unemployment: 1/" =0.5(1_1 - 14_2) a. Why might the natural rate of unemployment depend on recent unemployment (as is assumed in the preceding equation)? b. Suppose that the Fed follows a policy to reduce permanently the inflation rate by 1 percentage point. What effect would that policy have on unemployment rate over time? c. What is the sacrifice ratio in this economy? Explain. d. What do these equations imply about the short-run and long-run tradeoffs between inflations and unemployment? 7. If higher taxes cause people to want to work less and lower taxes cause people to want to work more. Consider this in the AS/AD-model: a. If this view is correct, how does a tax cut affect the natural rate of output? b. How does a tax cut affect the aggregate demand curve? The LRAS- and SRAS-curves? c. What is the short-run impact of a tax cut on output and the price level? How does your answer differ from the case without the labor-supply effect? d. What is the long-run impact of a tax cut on output and the price level? How does your answer differ from the case without the labor-supply effect?1.Suppose that the trade off between unemployment and inflations is determined by the Philips curve: 1 =u" -0(1 -7') Where u denotes the unemployment rate a" un the natural rate, # the rate of inflation, and " the expected rate of inflation. In addition, suppose that the Democratic party always follows a policy of high money growth and the Republican party always follows a policy of low money growth. What "political business cycle" pattern of inflation and unemployment would you predict under the following conditions? a. Every four years, one of the parties takes control based on a random flip of a coin. [Hint: What will expected inflation be prior to the election?] b. The two parties take turns. 2. When cities pass laws limiting the rent landlords can charge on apartments, the laws usually apply to existing buildings and exempt any buildings not yet built. Advocates of rent control does not argue that this exemption ensures that rent control does not discourage the construction of new housing. Evaluate this argument in light of the time inconsistency problem. 15. GOVERNMENT DEBT 1. Assume that the government sell public telecom company to the private sector. Does such actions by the government reduce the national debt as it is now measure? How would your answer change if the U.S government adopted capital budgeting? Do you think these actions represent a true reduction in the government's indebtedness? 2. Explaining and evaluating the Ricardian view of government debt. 3. The social Security system levies a tax on workers and pays benefits to the elderly. Suppose that congress increases both the tax and and the benefits. For simplicity, assume that the congress announces that the increases will last for one year only. a. How do you suppose this change would affect the economy? (Hint: Think about the marginal propensities to consume of the young and the old.) b. Does your answer depend on whether generations are altruistically linked? 4. Some economists have proposed the rule that the cyclically adjusted budget deficit always be balanced. Compare this proposal to a strict balanced budget rule. Which is preferable? What problems do you see with the rule requiring a balanced cyclically adjusted budget? 17. CONSUMPTION 1. Use the life-cycle model of consumption to discuss a change in the interest rate for a consumer who is a borrower in the first period. Discuss the income and substitution effects on consumption in both periods. 2. Jack an Jill both obey the two-period model of consumption. Jack earns $100 in the first period and $100 in the second period. Jill earns nothing in the first period and $210 in the second period. Both of them can borrow or lend at the interest rate. r? a. You observe both Jack and Jill consuming $100 in the first period and $100 in the second period. What is the interest rate r? b. Suppose the interest rate increases. What will happen to Jack's consumption in the first period? Is Jack better of or worse off than before the interest rate rise? C. What will happen to Jill's consumption in the first period when the interest rate increases? Is Jill better of or worse of than before the interest rate increases? 4. Explain whether borrowing constraints increase or decrease the potency of fiscal policy to influence aggregate demand in each of the following to cases: a. A temporary tax cut. b. An announced future fax cut. 6. Demographers predict that the fraction of the population that is elderly will increase over the next 20 years. What does the life-cycle model predict for the influence of this demographic change on the national saving rate? 7. One study found that the elderly who do not have children dissave at about the same rate as the elderly who do not have children. What might this finding imply about the reason the elderly do not dissave as much as the life-cycle model predicts