Econ

Diagram a market in which the equilibrium dollar price of 1 unit of fictitious currency zee (Z) is $5 (the exchange rate is $5 =Z1). Then show on your diagram a decline in the demand for zee. LO4 a. Referring to your diagram, discuss the adjustment options the United States would have in maintaining the exchange rate at $5 = Z1 under a fixed-exchange-rate system. b. How would the U.S. balance-of-payments surplus that is caused by the decline in demand be resolved under a system of flexible exchange rates

*look at graph* The decrease in demand for zees from D1 to D2 will create a surplus (ab) of zees at the $5 price. To maintain the $5 to Z1 exchange rate, the United States must undertake policies to shift the demand-for-zee curve rightward or shift the-supply-of zee curve leftward. To increase the demand for zees, the United States could use dollars or gold to buy zees in the foreign exchange market; employ trade policies to increase imports to U.S. from Zeeonia; or enact expansionary fiscal and monetary policies to increase U.S. domestic output and income, thus increasing imports from Zeeonia and elsewhere. Expansionary monetary policy could also reduce the supply of Zees: Zeeons could respond to the lower U.S. interest rates by reducing their investing in the United States. Therefore, they would not supply as many zees to the foreign exchange market. b. Under a system of flexible exchange rates, the ab surplus of zees (the U.S. balance of payments surplus) will cause the zee to depreciate and the dollar to appreciate until the surplus is eliminated (at the $4 = Z1 exchange rate shown in the figure) because U.S. would import more from Zeeonia and they would buy less from U.S. since zees lost value.

Explain how built-in (or automatic) stabilizers work. What are the differences between proportional, progressive, and regressive tax systems as they relate to an economy's built-in stability?

In a phrase, "net tax revenues vary directly with GDP." When GDP is rising so are tax collections, both income taxes and sales taxes. At the same time, government payouts—transfer payments such as unemployment compensation, and welfare—are decreasing. Since net taxes are taxes less transfer payments, net taxes definitely rise with GDP, which dampens the rise in GDP. On the other hand, when GDP drops in a recession, tax collections slow down or actually diminish while transfer payments rise quickly. Thus, net taxes decrease along with GDP, which softens the decline in GDP. A progressive tax system would have the most stabilizing effect of the three tax systems and the regressive tax would have the least built-in stability. This follows from the previous paragraph. A progressive tax increases at an increasing rate as incomes rise, thus having more of a dampening effect on rising incomes and expenditures than would either a proportional or regressive tax. The latter rate would rise more slowly than the rate of increase in GDP with the least effect of the three types. Conversely, in an economic slowdown, a progressive tax falls faster because not only does it decline with income, it becomes proportionately less as incomes fall. This acts as a cushion on declining incomes—the tax bite is less, which leaves more of the lower income for spending. The reverse would be true of a regressive tax that falls, but more slowly than the progressive tax, as incomes decline.

Suppose the government misjudges the natural rate of unemployment to be much lower than it actually is, and thus undertakes expansionary fiscal and monetary policies to try to achieve the lower rate. Explain why these policies might at first appear to succeed. Explain the long-run outcome of these policies

In the short-run there is probably a tradeoff between unemployment and inflation. The government's expansionary policy should reduce unemployment as aggregate demand increases. However, the government has misjudged the natural rate and will continue its expansionary policy beyond the point of the natural level of unemployment. As aggregate demand continues to rise, prices begin to rise. In the long-run, workers demand higher wages to compensate for these higher prices. Aggregate supply will decrease (shift leftward) toward the natural rate of unemployment. In other words, any reduction of unemployment below the natural rate is only temporary and involves a short-run rise in inflation. This, in turn, causes long-run costs to rise and a decrease in aggregate supply. The end result should be an equilibrium at the natural rate of unemployment and a higher price level than the beginning level. The long-run Phillips curve is thus a vertical line connecting the price levels possible at the natural rate of unemployment found on the horizontal axis.

Suppose that an economy begins in long-run equilibrium before the price level and real GDP both decline simultaneously. If those changes were caused by only one curve shifting, then those changes are best explained as the result of

The AD curve shifting left so this new point is recession which means employment has gone down so unemployment so policy makers can respond by expansion to shift curve

Suppose that you are a member of the Board of Governors of the Federal Reserve System. The economy is experiencing a sharp rise in the inflation rate. What change in the Federal funds rate would you recommend? How would your recommended change get accomplished? What impact would the actions have on the lending ability of the banking system, the real interest rate, investment spending, aggregate demand, and inflation?

To reduce inflation, the Federal funds rate should be raised. This would be accomplished typically through open-market operations (selling bonds), but could also be achieved with an increase in the reserve ratio or discount rate. The restrictive monetary policy would reduce the lending ability of the banking system, increase the real interest rate, reduce investment spending, reduce aggregate demand, and reduce inflation. -increase interest rates, including federal funds rate- you increase this by undertaking contractionary, raise discount rate