BECO1001 Section 004/005/006/007 Assignment 2

Student Name: Section Number:

Student Number:

1. In an economy MPC is constant and the full employment level of output is 7,000. , , or unchanged

(a) Complete the table below.

Y T Yd C S I G AE Unplanned S+T I+G Future
Inventory Output
Change Change
0 200 560 300
2,000 200 1,940 560 300
4,000 200 3,540 560 300
6,000 200 560 300
8,000 200 560 300

(b) What are the government spending multiplier, tax multiplier, and balanced-budget multiplier?

(c) What are the consumption function and saving function?

(d) What amount of change in government spending is required to achieve full employment and what will
be the consumption, saving, and budget deficit after the change?
when equilibrium output=7,000

(e) What amount of balanced-budget changes in government spending and tax are required to achieve full
employment and what will be the consumption, saving, and budget deficit after the change?
2. Let C=80+0.6Yd, I=120, G=200, T=100.

(a) What are government spending multiplier, tax multiplier, and balanced-budget multiplier?

(b) What are the output, consumption, saving, and budget deficit at the equilibrium?

(c) What are the output, consumption, and saving if the government changes the budget deficit to zero by a
change in G.

(d) What are the output, consumption, and saving if the government changes the budget deficit to zero by a
change in T.
3. The central bank holds $1,400 in government securities. The commercial banks have deposited $300
with the central bank and hold $100 in vault cash. $700 are held as currency by the public. The required
reserve ratio is 20%. Banks are loaned up.

(a) Fill the central bank’s T-account below.

Assets Liabilities
Gov’t securities Reserves
Currency in circulation

(This is not a complete T-account. The two sides may not be equal.)

(b) What is the money supply?

(c) The central bank would like to change the money supply to $2,300 either by an open market operation
or a change in the required reserve ratio.
(i) What should be the new ratio if the required reserve ratio is changed?

(ii) How much government securities should be purchased/sold if an open market operation is
undertaken?

, , or unchanged

(d) What will be the change in interest rate and security price after the change in (c)?
4. Let Md=3,00020,000r+0.5PY, PY=10,000, and Ms=6,000.
r

25%

20%

15%

10%

5%

4,000 5,000 6,000 7,000 8,000 9,000 M

(a) (i) Draw in the graph above the money demand curve and the money supply curve.
(ii) What is the equilibrium interest rate?

(b) If the nominal income PY rises 20% and the quantity of money supplied M s does not change,
(i) Draw the new money demand curve in the graph above.
(ii) What is the excess demand or supply of money before the interest rate change?
(iii) What is the new equilibrium interest rate?

(c) If the nominal income rises 20% and the central bank wants to keep interest rate unchanged,
(i) how much government securities should it buy or sell in the open market if the required reserve ratio is
16% and private banks do not hold excess reserves?
(ii) Draw the new money supply curve in the graph above.
 r=4%, Y=3,000
5. The graph below shows the Fed rule curve and the current equilibrium of an economy in which
- P is fixed
- MPC=80% => 1/MPS=5
- planned investment increases $40 whenever interest rate decreases 1% r decreases 1% => Y increases $40x5=$200
r

8%
Fed
6%

4%

2%

2,000 3,000 4,000 Y

(a) Draw the IS curve in the graph above.

(b) If government spending G increases $120, G increases $1 => IS curve shifts $5

(i) Draw the new IS curve in the graph above.

(ii) What are the interest rate and output at the new equilibrium?

(iii) What are the changes in planned investment and changes in output from the current
equilibrium to the new equilibrium?

(c) What is the government spending multiplier? If interest rate does not rise, G multiplier is 5.
Change in equilibrium output / change in G The crowding out effect makes it smaller than 5.
6. The graph below shows the current equilibrium in an economy (Y P: potential output).

AS0

P0

AD0

YP Y

If autonomous consumption increases,

(a) Show the SR and LR changes in the graph above. refer to Figure 11.9 in the lecture notes

(b) What are the changes in output and price level from the current equilibrium to the new short-run
equilibrium ?
, , or unchanged

(c) What are the changes in output and price level from the current equilibrium to the new long-run
equilibrium ?
 At the current equilibrium AS curve is flat
7. (a) An economy is currently far below capacity. Show the short-run changes in the AS/AD graph below
and predict the changes in the price level and aggregate output if firms increase capital investment.

or , how much? P

(b) An economy is currently near capacity. Show the short-run changes in the AS/AD graph below and
predict the changes in the price level and aggregate output if the central bank raises the required reserve
ratio. At the current equilibrium AS curve is steep

(c) Show the short-run changes in the AS/AD graph below and predict the changes in the price level and
aggregate output if energy price increases in the world market and the central bank tries to limit the rise of
the price level.
AS curve shifts AD curve shifts so that there will be not
much rise in P
P