MACROECONOMICS. 2011 FRQ. Norman. 2011 Macroeconomics FRQ. Assume that the U.S. economy is currently in a recession in a short-run equilibrium.
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(b) Draw a correctly labeled graph of AD/AS
in the recession and show each of the following.
(i) The LR equilibrium output, labeled Y
(II) The current equilibrium output and price levels,
labeled Ye and PLe, respectively.
(c) To balance the federal budget, suppose that the government decides to raise income taxes while maintaining the current level of government spending. On the graph drawn in part (b), show the effect of the increase in taxes. Label the new equilibrium output and price levels Y2 and PL2, respectively.
The Fed should buy bonds.
Answer to 1. (d)(i) and (ii)
The Fed will buy bonds which will increase
the MS [from MS1 to MS2] and decrease the
nominal interest rate.
Nominal Interest Rate
Answer to 1. (d)(iii)
The lower nominal interest rate would increase quantity of investment
demanded by businesses [would also increase consumption and Xn] which
would increase AD. The increase in AD would increase price level.
Answer to 1. (e) (i)
In the long run, prices would come down, and workers would accept lower
wages, decreasing resource cost to businesses, and they would hire
more workers as the SRAS curve would increase.
Answer to 1. (e)( ii)
With the SRAS curve shifting back to the right, this would bring the
economy back to equilibrium at the natural rate of employment. Because
we are back to the natural rate of unemployment, it did not change in the
2. Japan, the European Union, Canada, and Mexico have flexible exchange rates.
(a) Suppose Japan attracts an increased amount of investment from the EU.
(i) Using a correctly labeled graph of the loanable funds market in Japan, show the effect of the increase in foreign investment on the real interest rate in Japan.
(ii) How will the real interest rate change in Japan that you identified in part (a)(i) affect the employment level in Japan in the short run? Explain.
Loanable Funds Market
Real Interest Rate, (%)
Quantity of Loanable Funds
Answer to 2. (a) (i) & (ii)
(i) As can be seen on the graph, the increased investment in Japan would result in more yen
in Japan’s depository institutions, and increasing the supply of LF in Japan and decreasing
the real interest rate.
(ii) With the RIR decreasing in Japan, there will be more investment [a component of AD]which
would increase AD and GDP, therefore increasing employment in the short run.
2. (b) Suppose in a different part of the world, the real interest rate in Canada
increases relative to that in Mexico.
(i) Using a correctly labeled graph of the foreign exchange market for the Canadian dollar, show the effect of the change in real interest rate in Canada on the international value of the Canadian dollar (expressed as Mexican pesos per Canadian dollar).
(ii) How will the change in the international value of the Canadian dollar that you
identified in part (b)(i) affect Canadian exports to Mexico? Explain.
Answer to 2. (b)(i)
The higher RIR in Canada would
result in more demand for the
Canadian dollar by international
investors who are looking for
better returns. It increases
demand for the C. Dollar and
appreciates that currency.
Peso Price of Canadian Dollar
Answer to 2. (b)(ii)
The stronger Canadian dollar
would make Canadian exports
more expensive to Mexico,
therefore decreasing Canadian
exports to Mexico.
Quantity of Canadian Dollars
(a) Based on Sewell Bank’s balance sheet, calculate the required reserve ratio.
Answer to 3. (a)
The Fed’s RR would be 20% as DD is $10,000 and RR is $2,000
and excess reserves are $0.
(b) Suppose that the Fed purchases $5,000 worth of bonds from Sewell Bank.
What will be the change in the dollar value of each of the following
immediately after the purchase?
(i) Excess reserves
(ii) Demand deposit
ER would be $5,000 as any loan from the Fed is ER.
DD would not immediately increase as any money
from the Fed is all ER.
3. (c) Calculate the maximum amount that the MS can change as a result of the
$5,000 purchase of bonds by the Fed. .
Answer to 3. (c)
The Total Money Supply could potentially change to $25,000.
All of the $5,000 is ER for Sewell Bank so with a RR of 20% and a
MM of 5, $5,000 x 5 = TMS of $25,000.
3. (d) When the Fed purchases bonds, what will happen to the price of bonds
in the open market? Explain.
Answer to 3. (d)
When the Fed purchases bonds, the MS increases and people buy
non-money assets like bonds which pushes bond prices up and
interest rates down.
3. (e) Suppose that instead of the purchase of bonds by the Fed, an individual
deposits $5,000 in cash into her checking (DD) account. What is the
immediate effect of the cash deposit on the M1 measure of the MS?
Answer to 3. (e)
No impact. It stays the same although it changes composition from
$5,000 currency to $5,000 DD.
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