My home work, explained answers.

Government spending 300 Planned investment 200 Net exports 50 Autonomous taxes 250 Income tax rate 0.1 Marginal propensity to consume 0.5 a) [2 pts] Consumption (C) is 600 when income (Y) is equal to 1500. Solve for autonomous consumption. b) [4 pts] Solve for the equilibrium level of output in the following two scenarios: i) there is an income tax t=0.1, ii) there is no income tax in the economy. Denote these two variables by Y"w and Y" wa respectively. c) [2 pts] In the economy with an income tax of 10%, what is the budget balance of the government? d) [3 pts] Solve for the change in net exports that would bring the equilibrium output level in the economy with the income tax to the level of Y", that you found in part b. Specify both the magnitude of the change and whether it is an increase or a decrease. What would be the new level of net exports after this change? e) [4 pts] Suppose that we would like to achieve the same goal (as in part d) by changing the level of autonomous taxes instead of that of net exports. So, net exports remain at 50 and the level of autonomous taxes changes instead. Find the necessary magnitude of the change and specify whether autonomous taxes would have to increase or decrease. What would be the new level of autonomous taxes that accomplishes this goal?5:36 ( P VS P) - ... 60B/s 0 nil .ill C 80% Problem 5 (12 pts) You are given the following information: Bank deposits (D) 350 Currency-to-deposits ratio (c) 0.20 Required reserve ratio (r) 0.15 a) [2 pts] Solve for the monetary base level (B) in this economy. b) [2 pts] Solve for the level of bank reserves (R) in this economy. c) [2 pts] Solve for the money supply level (M) in this economy. d) [3 pts] Suppose there is a sudden rise in the currency-to-deposits ratio, from the original level of 0.2 to a new level of 0.4. If everything else remains unchanged, find the level of monetary base needed to keep money supply fixed at the level you solved for in part c. e) [3 pts] Continue to consider c=0.4. Find the level of required reserve ratio needed to keep the monetary base and the money supply fixed at the level you solved or in parts a and C, respectively. O5:49 ( P VS P) = ... OB/s 0 Fill .( 77% 13. THE KEYNESIAN MODEL IN THE SHORT AND LONG RUN WITH A POSITIVELY SLOPED SRAS-CURVE. THE AS/AD-model. 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 * = A_, -0.5(1 -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 3 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: a. 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 = 1_, -0.5(1-1") and that the natural rate of unemployment is given by an average of the past two years' unemployment: 1(" =0.5(11_1 - 10-2) 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. 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?5:52 ( P O vs pl ... OB/s 0 Fill all 77% 12. THE KEYNESIAN MODEL FOR THE SHORT RUN FOR A SMALL OPEN ECONOMY with a horizontal SRAS-curve. (The Mundell-Fleming model) Student should focus on floating exchange rates. 1.Use the Mundell-Fleming model to predict what would happen to aggregate income, the exchange rate, and the trade balance under both floating and fixed exchange rates in response to each of the following shocks: A. A fall in consumer confidence about the future induces consumers to spend less and save more. B. The introduction of a stylish line of Toyotas makes some consumers prefer foreign cars over domestic cars. C. The introduction of automatic teller machines reduces the real demand for money. 2. A small open economy with a floating exchange rate is in recession with balanced trade. If policymakers want to reach full employment while maintaining balanced trade, what combination of monetary and fiscal policy should they choose ? 3. The Mundell-Fleming model takes the world interest rate r as an exogenous variable. Let's consider what happens when this variable changes? A. What might cause the world interest rate to rise? B. In the Mundell-Fleming model with a floating exchange rate, what happens to aggregate income, the exchange rate, and the trade balance when the world interest rate rises? 4. Business executives and policymakers are often concerned about the "competitiveness" of American industry (the ability of U.S. industries to sell their goods profitably in world markets). a. How would a change in the exchange rate affect competitiveness? b. Suppose you wanted to make domestic industries more competitive but did not want to alter aggregate income. According to the Mundell-Fleming model, what combination of monetary and fiscal policies should you pursue? 5. Suppose that higher income implies higher imports and thus lower net exports. That is, the net exports function is: NX=NX(e, Y). Examine the effects in a small open economy of a fiscal expansion on income and trade balance under a floating exchange rate. 7. Suppose that the price level relevant for money demand includes the price of imported goods and that the price of imported goods depends on the exchange rate. That is, the money market is described by M/P=L(r,Y) where P= A . P.+ (1-1) . Pyle The parameter A is the share of domestic goods in the price index P. Assume that the price of domestic goods Id and the price of foreign goods measured in foreign currency Pf are fixed. B. What is the effect of expansionary fiscal policy under floating exchange rates in this model? Explain. Contrast with the standard Mundell-Fleming model. O