Topic #2: Inflation / Gdp / Unemployment

TOPIC #1: PPC / CIRCULAR FLOW

Assume a market economy with a business sector, a household sector, and a government sector, but no international sector.

a)Draw and label a circular flow diagram for this economy

b)Refer to the diagram you have drawn in part (a), identify two ways of calculating this economy’s gross domestic product (GDP)

c)Identify each of the following :

(i)the components of aggregate demand

(ii)the determinants of aggregate supply

(1997)

1997 question 2

a) put in households, businesses and government

put in the product market and the factor market

put in the flow of goods and the flow of factors (such as labor)

put in the flow of payments for the goods and for the factors

b) add up all spending (C + I + G)

add up all incomes (wages, rent, interest and profits)

c) AD = C + I + G + (X-M)

AS = costs of inputs (resources); productivity; taxes; govt regulations

TOPIC #2: INFLATION / GDP / UNEMPLOYMENT

Assume that in the United States, nominal wage rates rise faster than labor productivity. Analyze the short-run effects of this situation on each of the following:

a)the general price level

b)the level of exports

c)the international value of the dollar

(93)

1993 question 3

A)prices increase due to the cost-push effect; short-run AS shifts to the left

B)US goods are RELATIVELY more expensive than foreign goods; therefore, exports fall

C)Given the fall in demand for our exports, demand for the dollar will go down, therefore the value of the dollar will go down

(you can argue that because US goods are now RELATIVELY more expensive, demand for the RELATIVELY cheaper foreign goods by Americans will rise, and so Americans will be selling their US dollars to buy foreign currency; supply of the dollar will rise, and so the value of the dollar will fall)

Explain how some individuals are helped and others harmed by unanticipated inflation as they participate in each of the following markets

a)Credit markets

b)Labor markets

c)Product markets

(95)

1994question 3

a) borrowers benefit because they pay back money that is worth less (has less purchasing power); lenders are hurt because they receive back money that is worth less

b) employers benefit if the price of the good rises faster than wages; workers will be hurt if their real wages fall

c) if producers can raise their prices faster than costs of production, they win;

consumers are hurt because their real income is falling

Assume an open economy with a public sector

a)identify two methods of calculating gross domestic product for this economy

b)explain why the two methods you identified in part (a) must yield the same value of GDP

c)Identify one shortcoming of using GDP as an indicator of the actual level of national output

d)If nominal GDP increased by 4% in 1996, identify two additional pieces of information you need before you can conclude that the living standard of the typical person increased by 4% that year

(99)

1999 question 2

a) the expenditure approach: GDP = C + I + G + (X-M)

the income approach: add up wages, interest, rent and profits

b) expenditures (all spending) become incomes for other people

c) any of the following:

illegal economy understates the GDP

people may use barter

work from or in the home (housewife, fixing your own car etc)

externalities

d) we need the inflation rate to calculate REAL GDP

we need population growth to calculate GDP PER CAPITA

any change in income distribution; did only a few rich people benefit?

Are people working harder? Earning more money but giving up more leisure?

Are people paying higher prices but getting better products, which means they are not worse off due to the higher prices

TOPIC #3: AD / AS

assume that United States labor becomes more productive because of technological changes.

using the aggregate supply and aggregate demand model, explain how the increased productivity will affect each of the following for the United States:

a)output

b)price level

c)exports

explain how the change in exports you identified in C) will affect the international value of the dollar

(94)

1994question 3

part I: the major technological change increases productivity which causes the AS curve to shift to the right, resulting in a rise in GDP and jobs, and a fall in the price level (using intermediate AS curve)

as a result, US goods have become RELATIVELY less expensive compared to foreign goods, the demand for these US goods will rise, and so exports rise

part II: the increase in exports increases the demand for the US dollar, which will drive the value of the dollar up

In country X, labor productivity is growing at 3.2 per cent per year, and the nominal wage rate is constant

a)discuss the impact of this rate of growth in productivity on each of the following

(i)the price level

(ii)real wage rate

b)Now, the rate of growth of labor productivity in country X falls to 2.0 per cent per year, while the rate of growth of labor productivity in other countries remains constant and higher than in country X. Discuss the consequences of country X’s decline in relative productivity on each of the following

(i)exports of country X

(ii)the international value of country X’s currency

(iii)employment in country X in the short run

(98)

a) increase in productivity will shift AS to the right. GDP and jobs rise, price level will fall (assuming intermediate AS curve)

With prices falling, real wages (purchasing power) will rise

b) exports will fall as RELATIVE prices change against country X

a fall in demand for exports will cause a fall in demand for that country’s

currency; therefore, the value of the currency will fall.

Reduced production (lower exports) will lead to increased unemployment in the short run

Assume that an economy is at full employment

a)Explain how an increase in net investment will affect each of the following

(i)aggregate demand

(ii)capital stock

(iii)long-run aggregate supply

(iv)output

b) Explain how the increase in net investment will affect the country’s production possibilities curve shown below

(99)

1999 question 3

part a

(i) a rise in I will cause a rise in AD, since AD = C + I + G + (X-M)

(ii) the increase in net investment will cause an increase in the stock of capital goods

(iii) the increase in the capital stock will increase LONG RUN AGGREGATE SUPPLY, shifting LRAS to the right

(iv) increase in LRAS will cause an increase in POTENTIAL GDP (show it on the graph)

part b: PPC will shift outwards, because of the increase in the capital stock

TOPIC #5: MONETARY POLICY

the reserve requirement for the banking system is 20 per cent. Currently, Third National Bank has no excess reserves. Then Behroz deposits $100 in her checking account at Third National.

a)explain, without using a mathematical formula, why Behroz’ deposit can lead to a greater-than-$100 increase in the money supply

b)discuss TWO limitations of this process

(93)

1993 Question 2

Part A: Behroz deposits $100 in her bank account. The bank must put aside $20 in required reserves. The remaining $80 are considered EXCESS reserves, and may be loaned out to other customers. Fred borrows this $80, put the loan in his bank. Behroz can still spend her $100, while Fred can spend his $80. Thus, between them, they can spend $180; the money supply has expanded.

Part B: banks may choose to hold excess reserves; borrowers may not redeposit all of their loan in their bank; people may not be willing to borrow

Using the aggregate supply and aggregate demand model, explain how the use of monetary policy to promote long-run economic growth will affect each of the following:

a)short term interest rates

b)the composition (mix) of aggregate expenditures

c)potential gross domestic product

(1994)

1995question 2

part a: an increase in the money supply will cause interest rates to fall

part b: the fall in interest rates will cause an increase in investment (and other interest sensitive expenditures

part c: as a component of GDP where GDP = C + I + G + (X-M), I will rise relative to the other components

part d: the rise in investment (the purchase of capital goods) will cause a rise in LONG RUN AGGREGATE SUPPLY. The LRAS will shift to the right, the production possibilities curve will shift outwards, and POTENTIAL GDP will rise

A stranger arrive from outside a given economic system with $1,000 of acceptable currency that has never been in the system before. The nation’s banking system is governed by a central bank that has set a reserve requirement of 10 per cent.

a)Assume that the stranger deposits the $1,000 in a local bank. Explain the impact of this deposit on each of the following:

(i)the change in the dollar value of the local bank’s reserves

(ii)the maximum possible change in the dollar value of the local bank’s loans

(iii)the maximum possible change in the dollar value of the total money supply

b)State TWO factors in the real world that might cause this change in the money supply to be less than the maximum possible change

(96)

question 3 1996

part a:

(i) TOTAL reserves increase by $1000; $100 in required reserves, $900 in actual reserves

(ii) the bank is free to loan out a maximum of $900

(iii) $1000 deposited may expand to $10,000

part b:

borrowers may not redeposit all of their loans in their bank

banks may choose to keep EXCESS reserves

people may not be willing to borrow

Assume that the Federal Reserve System sells bonds in the open market, and that commercial banks hold no excess reserves.

a)Explain in detail how the Federal Reserve’s action affects the commercial banks’ reserves and interest rates

b)Show graphically what happens in the money market when the Federal Reserve sell bonds

c)Explain the effects of the Federal Reserve’s action on each of the following

(i)investment

(ii)aggregate demand

(iii)output

(iv)the price level

(98)

1998 question 2

a) the Fed sells bonds. This will reduce the money supply, as people pay for them with cash, so cash is sucked out of circulation. Bank reserves will go down, so interest rates will go up.

b) draw the Md / Ms graph, shift Ms to the left, show interest rates going up

a)the rise in interest rates will cause a fall in investment. The fall in investment will cause AD to go down. The AD curve shifts to the left. GDP goes down, jobs are lost and the price level goes down (assuming intermediate AS curve)

FISCAL POLICY / MONETARY POLICY / LONG RUN GROWTH

Suppose the following statements describe the current state of the United States economy:

--- the unemployment rate is 8 per cent

--- the consumer price index I s rising at 2 per cent annually

--- the annual growth rate of real gross domestic product is 1 per cent

Identify the major macroeconomic problems in this economy. Briefly explain why you consider them to be problems

II. Describe one policy action that the Federal Reserve Board and one that the fiscal authorities could

use to ease the problems you have identified. Explain in detail the short-run effect of your proposed actions on each of the following:

a)output and employment

b)prices

c)interest rates

III Considering long-run growth as well as short-run stabilization effects, which particular monetary or fiscal policy action or combination would you choose? Explain your choice.

(89)

answer

part I: major problem is unemployment (full employment is 4% unemployment)

part II: Fed could expand the money supply by buying bonds, lowering DR or lowering RR; increase in Ms lowers interest rates (show on graph); lower interest rates will increase investment; increase in investment will increase AD, GDP. Jobs and prices (assuming intermediate AS)

government could increase G, or cut T; increase in G increases AD; AD curve shifts to the right; GDP, jobs, and prices rise

government borrowing increases demand for loanable funds; interest rates rise

from both fiscal and monetary actions, GDP will rise, jobs will rise, prices will rise, effect on interest rate is INDETERMINATE

PART III: the monetary policy is more effective for the long run; with lower interest rates, the increase in investment will increase the capital stock; this will increase LONG RUN AGGREGATE SUPPLY, shift the LRAS to the right, increase POTENTIAL GDP, and shift the PPC outwards

Suppose that the following statements describe the current state of the United States economy

--- the economy is at full employment

--- the consumer price index is rising at 2 per cent annually

--- the federal government budget deficit is equal to $200 billion (5% of gross domestic product)

Legislation has just been passes which holds government spending constant and raises personal income taxes enough to balance the budget. Explain briefly how and why this policy will affect output and employment in the short run.

II. Following the income tax increase, the Federal Reserve announces a goal of significantly increased

growth rates in the money supply. If the Federal Reserve achieves its goal, explain in detail the

short-run effects of the Federal Reserve’s actions on each of the following:

(i)interest rates

(ii)output and employment

(iii)prices

Summarize the combined effects of the federal governments actions and the Federal Reserve’s

on long-run growth.

(90)

A series of natural disasters occur that cause the following changes in the United States economy:

--- the real gross domestic product drops by 4 per cent

--- the inflation rate rises from 5 per cent to 10 per cent

--- unemployment increases from 6 per cent to 10 per cent

use aggregate demand and supply analysis to explain what has happened to the economy

Suppose that the federal government, holding taxes constant, increases its spending and the Federal Reserve increases its purchases of bonds. Explain in detail the short-run effects of these actions on each of the following:

(i)output and employment

(ii)prices

(iii)interest rates

Explain how exports and imports will be affected by the changes in output and prices resulting from the policies described in section II.

(91)

1992Question 1

Part I: the series of natural disasters caused the AS curve to shift to the left. The result was that GDP fell and the price level rose, which is stagflation. As GDP falls, there will be a rise in unemployment, as businesses will hire fewer workers

Part II: Since GDP and AD = C + I + G + (X-M), an increase in G will shift the AD curve to the right; GDP will rise and jobs will be created, and the price level also rises (using intermediate AS curve). If the government increases its spending through borrowing (issuing bonds), the increase in demand for loanable funds will increase interest rates, and so the government may ‘crowd out’ private investment.

The buying of bonds by the Fed will increase the money supply. This will cause interest rates to fall. The fall in interest rates will increase Investment spending, and so aggregate demand will rise, increasing GDP, jobs, and prices

Part III: explanation (a): assuming foreign incomes and prices are constant, the rise in US prices will make US goods RELATIVELY more expensive to foreigners, and so exports will fall; likewise, foreign goods will be RELATIVELY cheaper, so imports will rise

Explanation (b): assuming interest rates fell (due to the FED), foreign investors will want to take their money out of the US (CAPITAL OUTFLOW); they will sell off their dollars, causing the dollar value to go down. US goods will be RELATIVELY cheaper to foreigners, so exports will go up; foreign goods will be RELATIVELY more expensive to Americans, so imports will go down

The United States experiences an increase in exports due to changes in the tastes and preferences of foreigners for United States goods. As a result, the following occur:

--- the real gross domestic product rises by 3 per cent

--- the inflation rate rises from 5 per cent annually to 10 per cent annually

--- the level of unemployment drops from 7 per cent to 5 per cent

use aggregate demand and supply analysis to explain what has happened in the economy

suppose that the Federal Reserve decides to sell bonds in the open market. Analyze the short-run effects of this action on each of the following:

(a)interest rates

(b)output and employment

(c)prices

explain the effects of the change in interest rates caused by the Federal Reserve’s action in II on each of the following:

a)the international value of the dollar

b)imports

c)exports

Now the federal government increases taxes while keeping its expenditures unchanged. Analyze the short-run effects of this action on each of the following:

a)output and employment

b)prices

c)interest rates

(92)

1993question 1

part I: using an AD / AS graph, the change in tastes and preferences of foreigners will shift the AD curve to the right, since a rise in X will cause a rise in AD. GDP will rise, jobs will be created, and the price level will rise (assuming intermediate AS curve)

part II:

a)when the FED sells bonds, the money supply will go down, and so interest rates will go up

b)the increase in interest rates will cause a fall in Investment, and so AD goes down; GDP falls and jobs are lost

c)the fall in AD will cause price level to fall

part III:

a) the rise in US interest rates will attract foreign investors who want to invest in the US. They will need to buy US dollars, demand for the dollar will go up, and so the price of the dollar (the exchange rate) will go up

b) the higher dollar value will make foreign goods RELATIVELY cheaper to Americans, so imports will rise