Open Questions

1.In each of the following cases, state whether the economy faces a recessionary or inflationary gap and outline possible fiscal policies (contractionary or expansionary). Suppose that full employment in the economy is when the unemployment rate is between 5% and 6%.

a.The unemployment rate is 4.5% and inflation is rising.

b.The unemployment rate is 8.5% and prices are stable.

2.The real output is failing and the unemployment rate is 9.5%.In each of the following cases, calculate the values of Marginal propensity to consume (MPC), Marginal propensity to withdraw (MPW) and the spending multiplier.

a.A $1 million increase in income leads to a $350,000 rise in consumption on domestic items.

b.A $4million decrease in income results in a $1 million drop in consumption on domestic items.

c.A $5 million decrease in income causes a $3million drop in withdrawals

3.Suppose Aggregate Demand fell by 20 billion CAD due to COVID19. Suppose that the government wants to pass a bill to parliament for R billion CAD in government stimulus to increase the Aggregate Demand back to where it was prior to COVID hit. Suppose that preliminary studies have found that the Marginal propensity to consume in the economy is 0.6.

a.Calculate the spending multiplier.

b.Find the amount of R that the government needs to pass to parliament in order to achieve the goal based on the estimate of the MPC.

c.Would a fiscal stimulus of 6 billion be enough?

4.What is the motive for holding money in each of the following cases: transaction, asset or precautionary (due to uncertainty)?

a.Concerned about the fluctuations of the stock market, you sell stock and keep cash in your brokerage account.

b.You go to Vancouver with the large sum of money in order to pass a holiday shopping.

c.You keep $20 in your glove compartment just in case you run out of gas.

5.Identify which of the three functions of money (medium of exchange, store of value, unit of account) is most relevant in the following situations:

a.A consumer compares prices on various brands of clothing to purchase.

b.A restaurant owner writes a cheque to pay for food purchases.

c.A wealth holder temporarily keeps part of her financial assets in a chartered bank deposit.

d.An accountant builds a balance sheet for a business owner using all sales receipts of the business.

5.Predict the impact of a decrease in the money supply on the following variables in the short run and in the long run, assuming nothing else would change.

a.The inflation rate.

b.The unemployment rate.

c.Real output.

d.Real wages.

True/False questions

6. Determine if the following statements are true or false.

___When the Bank of Canada purchases bonds in the economy the money supply increases ceteris paribus.

__An increase in the money supply by the Bank of Canada causes an increase the Aggregate Supply curve in the short run in the AD-AS model.

__ An expansionary fiscal policy increases the Aggregate Demand curve in the AD-AS model.

__An expansionary fiscal policy that is implemented while the Bank of Canada reduces its money supply would cause an increase in the Aggregate Demand curve in the AD-AS model.

__When the Bank of Canada sells T-Bills to the public it ends up reducing the money supply in the economy.

__Money neutrality in the long run means that the potential output that an economy can produce does not depend on the money supply.

__If the money multiplier is 10 then an injection in the economy of 10 billion CAD by the Bank of Canada would increase the overall money supply by more than 100 billion CAD.

__Expansionary monetary policy implies a lower interest rate in the economy, ceteris paribus.

__Contractionary monetary policy is adequate in a recessionary situation of the economy.