M a c r o e c o n o m i c s F r e e R e s p o n s e. 2007. Macro Free Response 2007. [Question 1 had 12 total points; Question 2 had 6 points; and Question 3 had 8 pts] 1. [3 pts] Assume that declining stock market prices in the U.S. cause many
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[Question 1 had 12 total points; Question 2 had 6 points; and Question 3 had 8 pts]
1. [3 pts] Assume that declining stock market prices in the U.S. cause many
U.S. financial investors to sell their stocks and increase their money holdings.
(a) Draw a correctly labeled graph of the money market and show the
impact of the financial investors’ actions on each of the following.
(i) Demand for money
(ii) Nominal interest rate
Nominal Interest Rate
1. (b) [3 pts] Due to the decline in wealth caused by the change in stock prices, the general price level in the U.S. falls relative to the price level in Japan, a trading partner. Use a correctly labeled graph of the foreign exchange market for the U.S. dollar to show the impact of the change in relative price levels on each of the following. (i) Demand for the dollar(ii) Price of the dollar
Yen Price of Dollar
Quantity of Dollars
Answers to 1. (b) (ii) [1 pt for saying the yen price of the dollar increased]
1. (b) (ii) Lower prices in the U.S. would cause an increase in demand for
the dollar, resulting in the Japanese having to pay more for American
goods. Therefore the yen would depreciate as the price of the dollar
has increased, and the dollar has appreciated.
Answer to 1. (c) The appreciated dollar would cause American goods to be more expensive for Japan and Japan’s goods to be less expensive for Americans; therefore, we would export less and import more, resulting in a decrease in net exports. [1 pt for Xn decreasing
and 1 point for saying U.S. goods are relatively more expensive]
(d) [3 pts]Using a correctly labeled
AD/AS graph, show how thechange
in Xn in part (c) will affect each of
the followingin theshort run.
(i) Aggregate Demand
(ii) Output and price level
Answer to 1. (d) [3 pts]
As can be seen on the graph, the
decrease in Xn would decrease AD.
The decrease in AD would decrease
output to Y2 and PL to PL2.
[1 pt for AD/AS graph, 1 pt for decr
In AD & 1 pt for PL & Y decreasing]
Answer to 1. (e) [1 pt for increase in
unemployment because Y decreased]
The decrease in Xn in part (d) will result
in a decrease in AD and output, which
would increase unemployment in the SR.
(e) [1pt] Given your answers to part
(d), what will happen to unemploy-
ment in the short run? Explain.
2.[6 total pts]In recent years, the Federal Reserve has made targeting the federal funds rate a main focus of its monetary policy. (a) Define the federal funds rate.
Answer: The rate that banks charge one another for overnight loans.
[1 point for saying this is the interest rate on loans between banks]
(b) If the Federal Reserve wants to lower the federal funds rate, what
open-market operation would be appropriate?
Answer: The Fed would buy bonds from the banks or public. Buying
bonds means a bigger supply of money and lower fed funds rate.
[1 point for saying the Fed would “buy bonds”.]
(c) Assume that the open-market operation that you indicated in part
(b) is equal to $10 million. If the RR is 0.2, calculate the maximum
change in loans throughout the banking system.
Answer: $40 million if the Fed buys the bonds from the public. The
public’s $10 million in DD could result in an increase in loans of
$40 million. ER of 8 M x Mm of 5 = $40 million in loans. If the Fed buys
bonds from banks, ER could increase by the $10 million initially and with a
Mm of 5, the increase in loans could be as much as $50 million.
[1 point for $40 million if the bonds were purchased from the public as the
$8 million ER x 5 would become $40 million or $50 million if the bonds were
purchased from banks. The $10 million x 5 would become $50 million.]
(d) Indicate the effect of the open-market operation that you indicated
in part (b) on the nominal interest rate.
Answer: Buying bonds would increase the MS and lower nominal Interest rates.
[1 point for saying the nominal interest rate decreases. A contingency point
would be “nominal interest rate increase” if he said “sell bonds” in part b]
(e) Assume that the Fed’s action results in some inflation. What would be the
impact of the open-market operation on the real rate of interest? Explain.
Answer: The RIR would fall as the assumption is the increase in inflation was not
anticipated. If the actual rate of inflation is greater than the anticipated rate, then
the RIR would fall. RIR=NIR-anticipated inflation. If we get more inflation than
anticipated, then RIR = NIR – more inflation than anticipated, so RIR decreases.
RIR falls because the NIR has decreased and inflation has increased.
[2 points: 1 pt for saying the real interest rate falls as inflation was more than
anticipated. RIR = NIR – anticipated inflation. 1 pt for saying the RIR falls
because the NIR has decreased and inflation increased. ]
Answer: No, it was counted the year it was produced. Because it was
not produced again, it would not be counted. That would be double counting.
[2 pts: 1 pt for saying not included and 1 pt for saying not produced in 2006]
3. [8 pts]Indicate whether each of the following is counted in
the U.S. GDP for the year 2006. Explaineach ofyour answers.
(a) The value of used textbook sold through online auction in 2006.
b. Rent paid in 2006 by residents in an apartment building built in 2000
Answer: Yes, rents consist of the income received by the households and
businesses that supply property resources. The properties have to be maintained
or “serviced” each year. It is included in the income approach to GDP.
[2 pts: 1 point for “yes” and 1 pt for saying this is the payment for services]
c. Commissions earned in 2006 by a stockbroker
Answer: Yes, payment is being made for productive services of the
broker. So the purchase of stocks would not count but his work would.
[2 pts: 1 pt for “yes” and 1 pt for saying this is the payment for services]
d. The value of autos produced in 2006 entirely in South Korea by a
firm fully owned by U.S. citizens
Answer: No, GDP measures production inside the U.S. regardless of
ownership. These autos were not produced in the U.S.
[2 pts: 1 pt for “not included” and 1 pt for saying not produced in U.S.]