Dr. Bell Name (print)_________________________
Econ-201
Homework #2

 

Homework is due at the beginning of class on Tuesday, April 8. As explained in the syllabus, no late homework will be accepted. If you are highly risk averse, you should turn in your homework early.

 

  1. The building block for Keynes’ aggregate demand curve is the consumption function. Keynes argued that consumption was primarily a function of current income. His consumption function can be written C = a + bY. The variable "b" turns out to be very important. In fact, it controls the slope of the aggregate demand curve. Write down everything you know about this variable.

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  2. Draw Keynes’ income-expenditure model (for an open economy with a government). Locate equilibrium and label the equilibrium level of output Y0. Now suppose that the marginal propensity to consume increases. Draw an AD curve that reflects this change. Label the new AD curve AD1, and label the new equilibrium level of output Y1. Explain how did an increase in the MPC affects the equilibrium level of employment.

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  3. Determine the equilibrium level of income for a closed economy if:

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                a = $100 billion; b = .85; I = $130 billion; and G = $90 billion

     

     

     

     

     

  4. Refer back to your answer in problem #3. Suppose that the government wants to bring the economy to full employment, which is believed to occur when the level of aggregate income is $3,300 billion. By how much would government spending have to increase in order to move the economy to full employment?

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  5. Refer back to problem #4. If the government had decided to cut taxes instead of increasing government spending, by how much would taxes have had to be lowered in order to close the recessionary gap?

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  6. Assume the economy is in recession and real GDP is below full employment. The MPC = .80, and the government increases spending by $500 billion. By how much will GDP ultimately increase?

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  7. If the marginal propensity to save is .06, what is the value of the tax multiplier?

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  8. If the MPS = .12 and the government increases taxes by $250 billion, by how much will GDP ultimately change?

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  9. Explain (in words) the paradox of thrift.

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  10. Explain (in words) why Keynes believed that investment was the most volatile component of aggregate demand.

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  11. Suppose that the economy is currently in equilibrium at Y = $10,000 trillion and that the President wants to pass a tax cut designed to move the economy to equilibrium at Y = $11,500 trillion. If the MPC = .91, by how much must taxes be cut in order to generate this increase in GDP?

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  12. What kinds of things might the government do in order to pursue contractionary fiscal policy? Is contractionary fiscal policy designed to increase or decrease GDP? Why would a government want to do this?

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  13. Suppose investment spending falls by $100 billion. By how much will consumption spending change in the subsequent two periods if the MPC is .93?

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  14. Define the Recessionary Gap:

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  15. Define the GDP Gap:

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  16. M1, M2 and M3 are all measures of the money supply. Define each.

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        M1 –

     

     

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        M3 –

     

     

     

  17. M1, M2 and M3 differ in their degree of liquidity. Define Liquidity.

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  18. What are bank reserves and why do banks hold reserves?

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  19. What does it mean to say that ours is a "fractional reserve system"?

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  20. Explain what would happen if everyone tried to convert their deposits to cash at the same time.

 

 

 

 

 

     21. Suppose the U.S. Treasury purchases 10 new airplanes from Boeing at a price of $50 million each and that the Treasury pays Boeing by             writing a check on its account at the Federal Reserve. Assume that the required reserve ratio is 6% and that banks initially have no excess             reserves. If banks lend all newly created excess reserves, by how much will the money supply ultimately increase?

 

 

 

 

 

 

 

  1. Explain (carefully) the Quantity Theory of Money (QTM).

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  2. There are three important ways that the Federal Reserve can influence the quantity of reserves. List them, and briefly describe how each could be used to increase or decrease bank reserves.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

24. If the required reserve ratio (RRR) is .07, what is the value of the money multiplier?

 

 

 

25. Who is the Chairman of the Federal Reserve?