Section A. True or False questions. Provide economic intuition or draw relevant diagrams to justify your answers.
Question:
Section A. True or False questions. Provide economic intuition or draw relevant diagrams to justify your answers. No marks are awarded if you merely state True or False as your answer.
1. Financial innovation that increases the velocity of money increases aggregate demand, prices and output in the short-run. [Hint: show your answer with a diagram]
2. In a large open economy, the expansionary fiscal policy brings about a deterioration in the net exports as worse off as the closed economy. [Hint: show your answer with a diagram]
3. The assumptions of free capital mobility and a small open economy dictate that the world real interest rate is equal to the domestic real interest rate.
4. Lenders and borrowers are equally worse off with inflation.
5. If the velocity of money is constant, money supply increases by 5%, output growth rate is 3%, and nominal interest rate is 5% then real interest rate is 3%.
Section B. Answer the following questions.
6.Consider a closed economy IS/LM model.
(a) Consumption is C = 200 + 0.75(Y - T) and investment is I = 200 - 50r.G = T = 0. Solve for the IS curve (i.e. an equation for Y in terms of r).
(b) Money demand is given by L = Y - 200r, the money supply is 1000 and the price level is P.Solve for the LM curve (i.e. an equation for Y in terms of r and P).
(c) Find the equilibrium interest rate of r and the equilibrium level of income (i.e. solve for where the IS and LM curves cross).
[Hint: express equilibrium interest rate of r and the equilibrium level of income in terms of p]
(d) The LRAS curve is Y* = 1000.What is the price level at which output is exactly equal to this?
(e) Now the money supply increases to 1200.What is the new equilibrium level of income (i.e. solve the IS/LM problem again with M = 1200).
[Hint: express equilibrium interest rate of r and the equilibrium level of income in terms of p]
(f) If prices remain at exactly the level you found in (d), what is the new level of income?Does the increase in money supply cause an expansion or contraction in income?
(g) What would prices have to be so that income is exactly equal to Y* = 1000 again?
7. (a) With the help of IS-LM diagrams, compare and contrast the causes of the 2008-2009 Great Recession (or Global Financial Crisis) with the 1930s Great Depression.
(b) Explain why the Great Recession did not result in the protracted and deeper recession of the 1930s Great Depression (as shown in the diagram below).
Expert Answer:
