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EXERCISE Question 1 (IS Curve and Short-run Fluctuation) The IS Curve shows the relationship between short-run output (Y,) and real interest rate (R,) on horizontal and vertical axes, respectively, expressed in percentage. The relationship is given by Y, = a - b(R; - 7), where a, b and 7 (marginal product of capital) are parameters. (a) If the output is at the potential (), = 0) when the real interest rate equals to F, what is the value of a? (b) How sensitive are the economy to the real interest rate? (Hint: Elasticity) (c) Plot the IS curve. Be careful on the values on the axes. (d) Suppose there is a technological advancement shock so that the potential output increases from It = 0 to It = a at the same real interest rate F. What does this represent on the IS curve? Draw the curve. Question 2 (The Multiplier) Recall from the class that if the consumption also depends proportionately on short-run output, namely, C:/Y. = a, + TY. We have the multiplier effect towards the IS curve such that ) = 1Ly [a - b (R. - 7)]. The multiplier is (a) If you want to draw the IS curve with multiplier, compare the slopes of the IS curves with and without the multiplier, what would be your conclusion? What if now, we also have that investment also depends proportionately on short-run output as well, namely, I/Y. = 0 -b(Re - F) + ZY (b) What would happen to the size of multiplier? (c) Is there any restriction on 7 and ?? (d) Facing recession, the government sees that the output drops by $100. The government wishes to restore the output level, what should be the size of tax cut to achieve this? Question 3 (Consumption Smoothing) Why should you take something from the future and consume today? The marginal utility from consuming T-bone steak is 100, 80, 60, 40, and 20 for the Ist, 2nd, 3rd, 4th, and 5th piece, respectively. Suppose you live for 2 periods. In Period 1, you have sufficient income for just 1 piece of steak. In Period 2, you have sufficient income for 5 pieces of steak. Assuming that you can shift the consumption across time without any cost, what should you do? Explain. Question 4 (The Monetary Policy - MP Curve) The MP curve is represented by the real interest rate equation, R = 4 - at, where i, and a, are nominal interest rate and inflation rate, respectively. One key assumption is that, inflation does not adjust quickly, namely, constant. The IS-MP diagram combines IS and MP curves with short-run output (Y,) and real interest rate (R,) on horizontal and vertical axes, respectively. (a) Suppose n = 2% and it = 4%, draw an MP curve. "b) Central banker uses the nominal interest rate as the policy instrument. Seeing the economic boom as the IS curve is shifted rightward, central bank must curb down the economic expansion by increasing the nominal interest rate. Draw two IS curves and two MP curves that exhibit this story.Lines and Equations of Lines Equation of a Line: y = mx + b The variables x and y are on horizontal and vertical axes, respectively. With this linear equation, the slope is m and y-intercept is b. 1. Consider a line given by the equation y = 4x + 2. a) What is the slope of this line? What is the relationship between the two variables? b) What are the x-intercept and y-intercept, that is, the points where the line intersects x-axis and y-axis, respectively? 2. A line is given by the equation y = -2x + 5. If it is shifted up by 2 units, what is the new equation of this line? Instead, if it is shifted to the left by 2 units, what is the new equation of this line? 3. Repeat question 3 when the equation of a line is given by y = 2x + 5 instead. Solving Two Equations 4. Solve for the intersection point, if exist, of the lines given by y = -2x + 5 and y = 4x + 2. 5. Solve for the intersection point, if exist, of the lines given by y = 50 - 10x and x = 2 Slope of Non-linear Curvess 6. Find the slope at point A and point B of the non-linear curve depicted below. 900 300 175 THE 12 14 Percentage Changes and Weighted Averages Percentage Change = 100 x (New Value - Old Value) / Old Value Weighted Average = Summation of the products between the Value and the Associated Weight 7. Suppose the price index were 1 10 in 2013, and 121 in 2014, what is the percentage change of the price index between the two years, that is, the inflation rate in 2014?Use the diagram to answer the next six (6) Computers questions 3. This PPF exhibits marginal opportunity costs. a) diminishing b) increasing c) constant 4. Which of the points above are unattainable? a) A b) B c) X d) z 39 65 Textbooks 5. Which of the above points are inefficient? a) A c) X 1) Z 6. Which of the above points are efficient? a) A )B c) X d) z e) A and B 7. Suppose an increase in productivity allows workers to increase their production of laptops. What would this mean for the graph above? a) Shift of the x-intercept; no shift of the y-intercept b) No shift of the x-intercept; shift of the y-intercept c) Shift of the x-intercept; Shift of the y-intercept d) No shift of the x-intercept; no shift of the y-intercept 8. If computers are considered as "capital good" while textbooks are considered as "consumption goods, which point is the country's growth rate likely to be the highest? a) A b) B 9. Which of the following is NOT true of households in the circular flow diargram? a) They receive income in exchange for providing the factors of production b) They purchase capital goods for use in production c) They purchase goods and services from the product market d) All of the above are true 10. Suppose the price of cheese curds rise from $1 to $2. What would we expect to occur in the market for cheese curds? a) Quantity demanded rises b) Quantity demanded falls c) Increase in demand d) Decrease in demand 1 1. Suppose the cost of grapes increase. What would we expect to occur in the market for wine? a) Quantity supplied rises b) Quantity supplied falls c) Increase in supply d) Decrease in supply12. Suppose that consumer interest in the Playstation 3 increases. At the same time, the price of the plastic used to make the Playstation 3 falls. How would this affect the price of the Playstation 3? a) Price would increase b) Price would decrease c) No change in price d) Indeterminate 13. In the previous example, how would that scenario affect the equilibrium quantity in the market for the Playstation 3? a) Quantity would increase b) Quantity would decrease c) Quantity would remain the same d) Indeterminate 14. Suppose that Coke and Pepsi are substitutes. If the price of Coke rises, what would happen to the demand curve for Pepsi? a) Shifts left b) Shifts right c) Moves along the demand curve to the left d) Moves along the demand curve to the right 15. Apart from Coke, Coca-Cola also produces Fresca. Suppose price of Fresca rises, what would happen to the supply curve of Coke? a) Shifts left (Supply of Coke decreases) b) Shifts right (Supply of Coke increases) c) Stays the Same d) Moves along the supply curve to the left 16. (The hardest question of the day, if you can do this, you've aced Chapter 3!) The market for corn in country A is highly competitive. At the current market price of $5/bushel, there is a shortage of 100,000 bushels of corn in this country. Media reports claim that the price of corn will rise drastically in the near future. According to these reports, the neighboring bounty B had witnessed a similar situation recently. At the same price of $5/bushel, the shortage in country B was also 100,000 bushels and eventually the equilibrium price in country B went up to exactly $10/bushel. Both countries are known to have equal number of corn producers and the market supply of corn is identical at all prices. This, combined with the fact that consumers in the two countries also have similar tastes and preferences, the new equilibrium price in country A turns out to be below $10/bushel. Which of the following inferences can be drawn? (Hint: We have said everything about identical supply curves in country A and country B. But we have not all things about consumers. Try drawing some graphs here!) a) The supply curve of corn must have shifted to the right. b) The average income level of people in country A must be lower than country B. c) The per capita consumption of corn in country A must be lower than country B. d) The quantity demanded at the new equilibrium in country A must be higher than the equilibrium quantity demanded at $10/bushel in country B. e) The demand curve for corn must be flatter in country A than in country B