Assignment 4 - Account towards final grade PDF

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Quantity Theory, Economic Policy, Exchange Rate Spring 2020

DSME 1040 D and F Economics for Business Studies II Assignment 4 Assignment 4 is due by 5pm, Apr 30 (Thursday). Please submit your answer via Blackboard. Late submission will lead to a deduction in points.

Section I: Multiple Choice Identify the letter of the choice that best completes the statement or answers the question.

1. If the economy is initially in long-run equilibrium, then shifts in aggregate demand affect prices a. and output in both the short and long run. b. and output only in the short run. c. in the long and short run, but affect output only in the short run. d. in the long and short run, but affect output only in the long run.

2. Suppose the economy is in long-run equilibrium. If there is a sharp increase in the minimum wage as well as an increase in pessimism about future business conditions, then we would expect that in the short-run, a. real GDP will rise and the price level might rise, fall, or stay the same. b. real GDP will fall and the price level might rise, fall, or stay the same. c. the price level will rise, and real GDP might rise, fall, or stay the same. d. the price level will fall, and real GDP might rise, fall, or stay the same.

3. Suppose the economy is in long-run equilibrium. If there is a sharp decline in the stock market combined with a significant increase in immigration of skilled workers, then we would expect that in the short run, a. real GDP will rise and the price level might rise, fall, or stay the same. In the long-run, real GDP will rise and the price level might rise, fall, or stay the same. b. the price level will fall, and real GDP might rise, fall, or stay the same. In the long-run, real GDP and the price level will be unaffected. c. the price level will rise, and real GDP might rise, fall, or stay the same. In the long run, real GDP will rise and the price level will fall. d. the price level will fall, and real GDP might rise, fall, or stay the same. In the long run, real GDP will rise and the price level will fall.

4. According to Keynes’ theory of liquidity preference, which variable adjusts to balance the supply and demand for money? a. interest rate b. money supply c. quantity of output d. price level

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5. Which of the following shifts money demand to the right? a. an increase in either the price level or the interest rate b. an increase in the price level or a decrease in the interest rate c. a decrease in the interest rate but not a change in the price level d. an increase in the price level but not a change in the interest rate 6. Opponents of active stabilization policy a. advocate a monetary policy designed to offset changes in the unemployment rate. b. argue that fiscal policy is unable to change aggregate demand or aggregate supply. c. believe that the political process creates lags in the implementation of fiscal policy. d. None of the above are correct.

7. According to liquidity preference theory, the money supply curve would shift right a. if the money demand curve shifted right. b. if the Federal Reserve chose to increase it. c. if the interest rate increased. d. if the price level fell or the interest rate decreased.

8. Assuming crowding-out but no multiplier effect, a $100 billion increase in government expenditures shifts aggregate a. demand right by more than $100 billion. b. demand right by $100 billion or less. c. supply left by more than $100 billion. d. supply left by less than $100 billion.

9. Depreciation of a currency is a. b. c. d.

the increase in the value of one currency in terms of another. the decrease in the value of one currency in terms of another. an arbitrary increase in the value of a currency that had previously been fixed in value. an arbitrary decrease in the value of a currency that had previously been fixed in value.

10. Which of the following policies would someone who wants the government to follow an active stabilization policy recommend when the economy is experiencing unemployment above the natural rate? a. decrease the money supply b. increase government expenditures c. increase taxes d. All of the above are correct.

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11. a. b. c. d.

Which of the following events would shift money demand to the right? an increase in the price level a decrease in the price level an increase in the interest rate a decrease in the interest rate

12. In a certain economy, when income is $100, consumer spending is $80. The value of the multiplier for this economy is 4. It follows that, when income is $101, consumer spending is a. $80.25. b. $80.75. c. $81.33. d. $84.00. 13. a. b. c. d.

Suppose that velocity rises while the money supply stays the same. It follows that P x Y must rise. P x Y must fall. P x Y must be unchanged. the effects on P x Y are uncertain.

14. a. b. c. d.

The logic of the multiplier effect applies only to changes in government spending. to any change in spending on any component of GDP. only to changes in the money supply. only when the crowding-out effect is sufficiently strong.

15. a. b. c. d.

If V and M are constant and Y doubles, the quantity equation implies that the price level falls to half its original level. does not change. doubles. more than doubles.

Section II: Short Questions

1.

Quantity Equation

Consider a hypothetical economy X. This year’s money supply is $500, nominal GDP is $10,000, and real GDP is $5,000. Assume that the velocity of money is constant and the economy’s real output of goods and services rises by 3% each year, a.

Find the price level next year if the central bank keeps the money supply constant. Next year M = $500 Y = 103/100*$5,000 = $5,150 P = $5,000*2/$5,150 = 1.94 b. Suppose the central bank wants an inflation of 2% next year, what is the target growth rate of money supply? If central bank wants an inflation of 2% next year and real GDP rises by 3% next year, then the target money growth rate is 5% (inflation + real GDP growth)

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2.

M1, M2, and Velocities From the figure below, you can see that M2 velocity (V2) is relatively more stable than its M1 counterpart. However, V2 can still change substantially during recessions. For example, V2 was 1.98 when the sub-prime crisis began in late 2007. It fell by approximately 20% to 1.57 in Q4, 2013.

a.

Define the velocity of money. Velocity of money is the speed at which money changes hands in an economy.

b.

Suggest reason(s) why V2 fell in this period. V2 fell during that period because during crisis economic activities are more uncertain. Thus, business activities (consumption, investment, lending and borrowing, etc.) would slow down, resulting in a fall on velocity. Figure: M1 and M2 Velocities in the US, 2000-2013

Source: Federal Reserve Bank of St. Louis (http://research.stlouisfed.org/fred2/).

3.

Aggregate Supply Explain whether each of the following events shifts the short-run aggregate supply curve, the longrun aggregate supply curve, or both.

a.

b.

4.

The economy experiences a wave of immigration. Both the SRAS curve and the LRAS curve will shift to the right because more people are in the labor force and more people will produce output. The minimum wage has just been increased by 5%. It is believed to have created more unemployment for the inexperienced youth and the elderly workers. With the minimum wage rule, firms’ cost on producing is higher thus resulting un unemployment which lead to a shift to the left in SRAS and LRAS. Both curves will shift because there is a decrease in the labor force.

True or False Briefly explain why the statement is true or false.

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a. The multiplier has a bigger value in the presence of taxation. False because income will be smaller with the presence of taxation (some of the income will go to the government as tax payments) thus resulting in the smaller amount of spending/consumption. b. The government can always use an expansionary fiscal policy to increase real GDP. False because an expansionary fiscal policy only increases GDP in the short run (by shifting AD curve to the right). In the long run, real GDP will be equal to potential GDP thus making the policy ineffective to raise real GDP.

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