Macroeconomics 1 – Seminar 10
28.04.2015
Miroslava Federičová
The theory by John Maynard Keynes arguing
that the interest rate adjusts to bring money
supply and money demand into balance is called
the:
a. liquidity adjustment theory.
b. money demand theory.
c. liquidity preference theory.
d. money supply theory
If the interest rate is above equilibrium in the
Money Market,
people will be holding more/less money than
they want to,
so they will want to deposit in interest bearing
accounts more/less than before.
If the interest rate is below equilibrium in the
Money Market, people will choose to ________
their interest bearing accounts in banks, causing the
interest rate in the economy to ________.
a. deposit some money into, increase
b. deposit some money into, decrease
c. withdraw some money from, increase
d. withdraw some money from, decrease
The money supply curve is:
a. upward sloping, because people wish to lend
more at higher interest rates.
b. upward sloping, because people want to hold
less money at higher interest rates.
c. vertical, because the Fed controls and determines
the amount of money in the economy.
d. downward sloping, because people want to hold
less money at higher interest rates.
When the government increases its expenditures,
the multiplier effect will ________ its impact on
aggregate demand,
and the crowding out effect will ________.
a. enhance, dampen it
b. enhance, enhance it as well
c. dampen, dampen it as well
d. dampen, enhance it
If the government cuts taxes by $100 billion,
aggregate expenditure:
a. will increase by $100 billion right away.
b. might not change at all, if people perceive the tax
cut to be temporary.
c. will increase more than if the government had
instead increased spending by the $100 billion.
d. will decrease, as the government will be forced
to cut spending to meet its lower tax revenue
When an economy is in recession, household
incomes tend to decrease, which results in
households paying
a. more taxes, thus helping stimulate the economy.
b. fewer taxes, further dampening the economy.
c. more taxes, further dampening the economy.
d. fewer taxes, thus helping stimulate the economy.
Suppose the government increases its spending
by $200 billion.
How much will aggregate demand increase
overall, if the marginal propensity to consume is
0.9 and if we assume there is no crowding out?
$2,000 billion ($2 trillion)
Explain how each of the following developments would affect the supply of
money, the demand for money, and the interest rate. Illustrate your answer
with diagrams.
A) The Fed’s bond traders buy bonds in open-market operations. Shift in the
money supply to the right, i.e. decrease in interest rate
B) An increase in credit-card availability reduces the cash people hold.
Shift in money demand to the left and decline in interest rate
C) The Central bank reduces banks’ reserve requirements.
Shift in the money supply to the right, i.e. decrease in interest rate
D) Households decide to hold more money to use for holiday shopping. Shift
in money demand to the right and increase in interest rate
E) A wave of optimism boosts business investment and expands aggregate
demand.
Shift in money demand to the right and increase in interest rate
Suppose a computer virus disables the nation’s automatic teller
machine, making withdrawals from bank accounts less convenient. As
a result, people want to keep more cash on hand, increasing the
demand for money.
A) Assume the Fed does not change the money supply. According to
the theory of liquidity preference, what happens to the interest
rate? What happens to aggregate demand? Shift in money demand
to the right causes increase in interest rate. Because of higher costs
of borrowing and returns to saving, aggregate demand shifts to the
left
B) If instead the Fed wants to stabilize aggregate demand, how should
it change the money supply? The Fed should increase money
supply. This shift in money supply would offset the change in
interest rate.
C) If it wants to accomplish this change in the money supply using
open-market operations, what should it do? The Fed should buy
government bonds.
HW 3 – Problem 1
In Table below are data for the price of Big Macs in several countries. The U.S.
price of a Big Mac is $3.57.
1. For each country compute the predicted exchange rate of the local
currency per U.S. dollar. Numbers in red in the Table above
2. According to purchasing-power parity, what is the predicted exchange rate
between Hungarian forint and Canadian dollar? What is the actual
exchange rate? The predicted exchange rate is 185.03 forints/C$ and
actual is 171.55 forints/C$.
3. How well does the theory of purchasing-power parity explain exchanges
rates? The theory of PPP says that you should buy the same good for the
same price everywhere. This is not true always (transaction costs, ...). In
the Table, we can see differences between predicted and actual ER that is
some countries larger and in other countries only marginal.
Country Price of a Big
Mac
Predicted Exchange
Rate
Actual Exchange
Rate
Chile 1,750 pesos 490.20 pesos/$ 549 pesos/$
Hungary 720 forint 201.68 forints/$ 199 forints/$
Czech Republic 67.9 korunas 19.02 korunas/$ 18.7 korunas/$
Brazil 8.03 real 2.25 real/$ 2.00 real/$
Canada 3.89 C$ 1.09 C$/$ 1.16 C$/$
Over the past decade, some of Chinese saving has been used to
finance American investment. That is, the Chinese have been buying
American capital assets. Answer the following questions in words and
with a diagram.
1. If the Chinese decided they no longer wanted to buy U.S. assets, what
would happen in the U.S. market for loanable funds? In particular, what
would happen to U.S. interest rates, U.S. saving, and U.S. investment? In
this situation, NCO increases, i.e. demand curve in the market for
loanable funds shifts to the right. This induces interest rate to rise, U.S.
saving to rise and U.S. investments to fall.
2. What would happen in the market for foreign-currency exchange? In
particular, what would happen to the value of the dollar and the U.S.
trade balance?
The supply curve in the market for foreign currency exchange shifts to the
right that causes depreciation. Trade balance, i.e. net export, increases.
HW 3 – Problem 2
The economy begins in long-run equilibrium. Then one day, the president
appoints a new chairman of the Federal Reserve. This new chairman is
well-known for his view that inflation is not a major problem of an
economy.
1. How would this news affect the price level that people would expect to
prevail? People expect higher prices.
2. How would this change in the expected price level affect the nominal
wage that workers and firms agree to in their new labor contracts?
They will agree on higher nominal wages (as they expect higher
inflation)
3. How would this change in the nominal wage affect the profitability of
producing goods and services at any given price level? Because of
higher wages, the costs of production increase and the profitability
decline.
4. How does this change in profitability affect the short-run aggregatesupply
curve? The short run aggregate supply curve shifts to the left.
5. If aggregate demand is held constant, how does this shift in the
aggregate-supply curve affect the price level and the quantity of
output produced? This shift causes increase in the price level and
decline in output.
HW 3 – Problem 3