Principles of Macroeconomics (Chp 13 -16)

Refer to Figure 13-1. Ceteris paribus, a decrease in personal income taxes would be represented by a movement from

AD 1 to AD 2

Refer to Figure 13-1. Ceteris paribus, an increase in interest rates would be represented by a movement from

AD 2 to AD 1

Refer to Figure 16-1. An increase in taxes would be depicted as a movement from ________, using the static AD- AS model in the figure above.

B to A

Refer to Figure 16-1. Suppose the economy is in short-run equilibrium above potential GDP and wages and prices are rising. If contractionary policy is used to move the economy back to long run equilibrium, this would be depicted as a movement from ________ using the static AD- AS model in the figure above.

C to B

An increase in government spending lowers interest rates and increases the rate of investment in new capital

False

To reassure investors who were unwilling to buy mortgages in the secondary market, the U.S. Congress used two government sponsored enterprises, ________, to sell bonds to investors and use the funds to purchase mortgages from banks.

Fannie Mae and Freddie Mac

President Bush lowered income taxes for individuals in 2001. Explain how lower income taxes affect the aggregate demand curve.

Lowering the income tax inflates the amount of disposable income available to households. Higher disposable income increases consumption at every price level. The outcome is a shift in the aggregate demand curve to the right.

Consider the Taylor rule for the target of the federal funds rate. Suppose the equilibrium real federal funds rate is 2 percent, the target rate of inflation is 3 percent, the current inflation rate is 3 percent, real GDP equals potential real GDP, and the weights are 1/2 for the inflation gap and the output gap. Using the Taylor rule, what does the target for the federal funds rate equal? Next, if the Federal Reserve lowered the target for the inflation rate to 1 percent, how much would the target for the federal funds rate change?

The federal funds target rate would equal 5 percent. With no inflation gap or output gap, the federal funds target rate equals the current inflation rate plus the equilibrium real federal funds rate. A decrease in the inflation target from 3 percent to 1 percent with a weight on the inflation gap of 1/2 would raise the federal funds target rate by 1 percentage point, from 5 percent to 6 percent.

In the dynamic aggregate demand and aggregate supply model, what is the result of aggregate demand increasing slower than potential real GDP?

The result of aggregate demand increasing slower than potential real GDP will cause a recession.

The cyclically adjusted budget deficit or surplus measures what the deficit or surplus would be if the economy was

at potential GDP

If a person takes $100 from his/her piggy bank at home and puts it in his/her savings account, then M1 will ________ and M2 will ________.

decrease; not change

The "interest rate effect" can be described as an increase in the price level that raises the interest rate and chokes off

investment and consumption spending

Refer to Figure 13-4. Given the economy is at point A in year 1, what will happen to the unemployment rate in year 2?

it will rise

Crowding out refers to a decline in ________ as a result of an increase in ________.

private expenditures; government purchases

If the Fed raises the interest rate, this will ________ inflation and ________ real GDP in the short run.

reduce; lower

Which of the following functions of money would be violated if inflation were high?

store of value

German luxury car exports were hurt in 2009 as a result of the recession. How would this decrease in exports have affected Germany's aggregate demand curve?

The aggregate demand curve would have shifted to the left.

Which of the following would be classified as fiscal policy?

The federal government cuts taxes to stimulate the economy.

Use the dynamic aggregate demand and aggregate supply model and start with Year 1 in a long-run macroeconomic equilibrium. For Year 2, graph aggregate demand, long-run aggregate supply, and short-run aggregate supply such that the condition of the economy will induce the president and Congress to conduct expansionary fiscal policy. Briefly explain the condition of the economy and what the president and Congress are attempting to do.

The president and Congress conduct expansionary fiscal policy to increase real GDP to potential real GDP. In the graph below, the economy would move from point A in Year 1 to point B in Year 2 without any expansionary fiscal policy. At point B, real GDP is below potential real GDP. The president and Congress would increase government purchases or decrease taxes to stimulate aggregate demand, trying to push the economy to potential.

Starting from long-run equilibrium, use the basic aggregate demand and aggregate supply diagram to show what happens in both the long run and the short run when there is an increase in wealth.

There is a decrease in households' wealth due to a decline in the stock market. Household consumption drops as wealth declines which as also decrease spending at any given price level and reduces the price they are willing to pay for goods. The falling price level along with given wages raises the cost of hiring workers and output declines in equilibrium. Equilibrium price and output drop to point 2. The falling price level combined with fixed wages will raise the relative or real wage as the economy goes into a recession. The relatively low demand for labor in the recession will put downward pressure on the nominal wage rate. The falling cost of production reduces the prices that firms demand for their production (the SRAS curve shifts down). Wages will fall until the labor market equilibrium return relative wages to their long-term levels. The new long run equilibrium will be at point 3.

The recession of 2007-2009 made many consumers pessimistic about their future incomes. How does this increased pessimism affect the aggregate demand curve?

This will shift the aggregate demand curve to the left

Inflation targeting has typically been accompanied by lower inflation.

True

The income tax system serves as an automatic stabilizer over the course of the business cycle.

True

When potential GDP increases, long-run aggregate supply also increases.

True - When potential GDP increase, LRAS will shift to right.

Suppose the economy is at full employment and firms become more optimistic about the future profitability of new investment. Which of the following will happen in the short run?

Unemployment will decline

Which of the following would cause the money demand curve to shift to the left?

a decrease in real GDP

Refer to Figure 16-5. In the dynamic model of AD- AS in the figure above, if the economy is at point A in year 1 and is expected to go to point B in year 2, and no fiscal or monetary policy is pursued, then at point B

firms are operating below capacity

The goals of monetary policy tend to be interrelated. For example, when the Fed pursues the goal of ________, it also can achieve the goal of ________ simultaneously.

high employment; economic growth

If a bank receives a $1 million discount loan from the Federal Reserve, then the bank's reserves will

increase by $1 million

An increase in the interest rate should ________ the demand for dollars and the value of the dollar, and net exports should ________.

increase; decrease

The multiplier effect is the series of ________ increases in ________ expenditures that result from an initial increase in ________ expenditures.

induced; consumption; autonomous

Which of the following information about fiat money is false? Fiat money

is backed by gold

If households choose to take some fraction of each check they deposit and hold it as currency, then the simple deposit multiplier ________ the real-world multiplier.

is greater than

Although the Federal Reserve had traditionally made discount loans only to commercial banks, in response to the financial crisis in 2008 the Fed made ________ eligible for discount loans as well.

primary dealers

When banks gain ________, they can ________ their loans; and the money supply ________.

reserves; increase; expands

The process of bundling loans together and buying and selling these bundles in a secondary financial market is called

securitization

Workers expect inflation to rise from 3% to 5% next year. As a result, this should

shift the short-run aggregate supply curve to the left

A monetary policy target is a variable that the Fed can affect directly, which then affects one or more of the Fed's policy goals.

true

If banks receive a greater amount of reserves and do not hold all of these reserves as excess reserves, the money supply expands.

true

Inflation is generally the result of total spending growing faster than total production.

true

The statement "This Dell laptop costs $1,200" illustrates which function of money?

unit of account

If real GDP is $300 billion below potential GDP and the tax multiplier equals -1.5, then how much would the government need to change taxes to bring the economy to equilibrium at potential?

Δ real GDP / Δ tax (= tax multiplier) $300 billion / Δ tax = -1.5 Δ tax = $300 billion / -1.5 = -$200 billion the government should cut tax by $200 billion

Imagine that Kristy deposits $10,000 of currency into her checking account deposit at Bank A and that the required reserve ratio is 20%. Refer to Scenario 14-2. As a result of Kristy's deposit, Bank A's excess reserves increase by

$8,000 [If deposit incresae by $10,000. Required reserve will increase 10000*0.2=$2000 Hence excess reserve will incresae by 10000-2000=8000 which can be loaned out.]

Suppose Warren Buffet withdraws $1 million from his checking account at Chase Bank. If the required reserve ratio is 20 percent, what is the maximum change in deposits in the banking system?

-$5 million

Refer to Figure 13-4. Given the economy is at point A in year 1, what is the inflation rate between year 1 and year 2?

1.8%

Using the quantity equation, if the velocity of money grows at 5 percent, the money supply grows at 10 percent, and real GDP grows at 4 percent, then the inflation rate will be

11 %

Suppose the equilibrium real federal funds rate is 5 percent, the target rate of inflation is 3 percent, the current inflation rate is 5 percent, and real GDP is 4 percent above potential real GDP. If the weights for the inflation gap and the output gap are both 1/2, then according to the Taylor rule the federal funds target rate equals

13%

If the required reserve ratio is 5 percent, then the simple deposit multiplier is

20

Refer to Figure 15-7. Suppose the economy is in a recession and the Fed pursues an expansionary monetary policy. Using the static AD- AS model in the figure above, this would be depicted as a movement from

A to B

Refer to Figure 16-1. Suppose the economy is in short-run equilibrium below potential GDP and no fiscal or monetary policy is pursued. Using the static AD- AS model in the figure above, this would be depicted as a movement from

A to E

Refer to Figure 13-3. Suppose the economy is at point A. If government spending increases in the economy, where will the eventual long-run equilibrium be?

C

Refer to Figure 13-3. Suppose the economy is at point A. If investment spending increases in the economy, where will the eventual long-run equilibrium be?

C

Which of the following is one explanation as to why the aggregate demand curve slopes downward?

Decreases in the price level raise real wealth and increase consumption spending.

Use a graph to show the effects of a contractionary monetary policy to reduce inflation and move an economy back to potential real GDP. Explain what happens to aggregate demand, real GDP, and the price level.

If the economy is experiencing inflation, it is currently at point A, beyond potential real GDP. A contractionary monetary policy will shift the aggregate demand curve to the left from AD1 to AD2, decreasing real GDP and the price level until it reaches potential real GDP at point B.

Refer to Figure 13-2. Ceteris paribus, a decrease in productivity would be represented by a movement from

SRAS 2 to SRAS 1

Refer to the Article Summary. When does the Treasury Department borrow? Why would the Treasury have to borrow more than it estimated, as was indicated by its letter to Congress to raise the debt ceiling? When would the Treasury repay what it borrowed, and who is it repaying?

The Treasury Department borrows from the public to finance government purchases and the fed purchases the debt in the form of treasury bills (monetizing the debt). The Treasury Department would be forced to use "extraordinary measures" to keep raising cash to pay the government's bills. Congress has missed the deadline to raise the debt limit in the past, but it has always taken action before the Treasury actually ran out of money to pay its creditors. In 2011, lawmakers failed to raise the debt ceiling by that year's May deadline, resulting in Standard & Poor's downgrading the government's credit rating for the first time in history. It is possible that the U.S. goes back into recession and spark a global economic crisis. The government wouldn't be able to pay back people who invested in U.S. Treasury bonds. Those bondholders range from individual Americans and their pension plans to the Chinese and Japanese governments. Because the U.S. government spends more that it collects in taxes, it relies on these investors to help raise revenue. Failing to pay back investors would cause the value of U.S. bonds to plummet. At the same time, the government would have to pay a higher return to investors because bonds would no longer be seen as a safe investment. That could cause interest rates to go up throughout the world because global rates are tied to the value of U.S. bonds. [When tax revenues are not sufficient to pay the federal government's bills, the Treasury borrows the necessary funds. The Treasury would need to borrow more than it estimated if the federal budget deficit is larger than was estimated. The Treasury would repay borrowed funds if the federal budget is in surplus, and it is repaying the investors who had bought its bonds].

Imagine that Kristy deposits $10,000 of currency into her checking account deposit at Bank A and that the required reserve ratio is 20%. Refer to Scenario 14-2. As a result of Kristy's deposit, Bank A's reserves immediately increase by

$10,000

Which of the following would not be considered an automatic stabilizer?

Legislation increasing funding for job retraining passed during a recession

According to the Taylor rule, does the target for the federal funds rate respond differently for an increase in inflation caused by an increase in aggregate demand and for an increase in inflation caused by a decrease in short-run aggregate supply? Explain whether there is or is not a difference in how the target for the federal funds rate changes.

The target for the federal funds rate reacts differently. The current inflation rate and inflation gap are the same, but the output gap is different. The output gap is the percentage difference between real GDP and potential real GDP and is positive for the inflation caused by an increase in aggregate demand. But is negative for the inflation caused by a decrease in short-run aggregate supply. The target for the federal funds rate will be higher in the circumstance that the increase in inflation caused by an increase in aggregate demand.

Refer to Table 15-8. The hypothetical information in the table shows what the values for real GDP and the price level would have been in 2014 if the Federal Reserve did not use monetary policy: a. If the Fed wanted to keep real GDP at its potential level in 2014, should it have used an expansionary policy or a contractionary policy? Should the trading desk have bought T-bills or sold them? b. Suppose the Fed's policy was successful in keeping real GDP at its potential level in 2014. State whether each of the following would be higher or lower than if the Fed had taken no action: c. Draw an aggregate demand and aggregate supply graph to illustrate your answer. Be sure that your graph contains LRAS curves for 2013 and 2014; SRAS curves 2013 and 2014; AD curve for 2013 and 2014, with and without monetary policy actions; and equilibrium real GDP and the price level in 2014 with and without policy.

a. The Fed should have used contractionary monetary policy. The trading desk needed to sell T-bills. b. If the Fed's contractionary policy was successful, real GDP in 2014 would be lower as would the inflation rate. Full-employment real GDP would not change and the unemployment rate would rise. c. The economy starts out in equilibrium in 2013 at point A. In 2014, with no contractionary monetary policy, the economy would go to point B with real GDP above potential real GDP and the price level at 150. Contractionary monetary policy would slow down the growth of aggregate demand and the economy would reach equilibrium at point C.

In the long run, most economists agree that a permanent increase in government spending leads to ________ crowding out of private spending.

complete

From an initial long-run macroeconomic equilibrium, if the Federal Reserve anticipated that next year aggregate demand would grow significantly slower than long-run aggregate supply, then the Federal Reserve would most likely

decrease interest rates

Refer to Figure 15-11. In the dynamic model of AD- AS in the figure above, if the economy is at point A in year 1 and is expected to go to point B in year 2, the Federal Reserve would most likely

decrease interest rates

To combat a recession with discretionary fiscal policy, Congress and the president should

decrease taxes to increase consumer disposable income

Last week, six Swedish kronor could purchase one U.S. dollar. This week, it takes eight Swedish kronor to purchase one U.S. dollar. This change in the value of the dollar will ________ exports from the United States to Sweden and ________ U.S. aggregate demand.

decrease; decrease

Part of the spending on the Doyle Drive project in northern California came from the American Reinvestment and Recovery Act, which is an example of ________ aimed at increasing real GDP and employment.

discretionary fiscal policy

Refer to the Article Summary. Implementing a negative interest rate policy, as was advocated by the president of the Federal Reserve Bank of Minneapolis, would be an example of ________ monetary policy designed to ________ aggregate demand.

expansionary; increase

Refer to the Article Summary. The unexpected increase in the supply of oil mentioned in the article summary resulted in a decrease in the price of oil. When the price of oil falls unexpectedly due to a supply shock, the equilibrium price level ________ and the unemployment rate ________ in the short run.

falls; falls

Contractionary monetary policy refers to the Fed's decreasing the money supply and decreasing interest rates to decrease real GDP.

false

Refer to Scenario 14-1. M2 in this simple economy equals Currency: $1,000 Checking Account Balances: $2,000 Savings Account Balances: $5,000 Small- Denomination Time Deposits: $6,000 Noninstitutional Money Market Fund Shares: $7,000

$21,000

Refer to Table 14-1. Suppose a transaction changes a bank's balance sheet as indicated in the T-account, and the required reserve ratio is 10 percent. As a result of the transaction, the bank has excess reserves of Assets - Reserves: $4,000 Liabilities - Depositis: $4,000

$3,600

Suppose a bank has $100 million in checking account deposits with no excess reserves and the required reserve ratio is 20 percent. If the Federal Reserve reduces the required reserve ratio to 15 percent, then the bank will now have excess reserves of

$5 million

Imagine that Kristy deposits $10,000 of currency into her checking account deposit at Bank A and that the required reserve ratio is 20%. Refer to Scenario 14-2. As a result of Kristy's deposit, checking account deposits in the banking system as a whole (including the original deposit) could eventually increase up to a maximum of

$50,000

Refer to Figure 13-4. In the figure above, AD 1, LRAS 1 and SRAS 1 denote AD, LRAS and SRAS in year 1, while AD 2, LRAS 2 and SRAS 2 denote AD, LRAS and SRAS in year 2. Given the economy is at point A in year 1, what is the actual growth rate in GDP in year 2?

7.3%

Explain why the tax multiplier is different from the government purchases multiplier, in both sign and relative magnitude.

A dollar change in government purchases does the opposite impact of a dollar change in taxes. An increase in government purchases increases income, spending, and GDP in the economy. But however, an increase in taxes lowers income, spending, and GDP in the economy. The outcome is that the government purchases multiplier is positive, and the tax multiplier is negative. A dollar change in government purchases will have a larger effect on GDP as compared to a dollar change in the tax multiplier. A change in government purchases effects overall spending. A change in taxes affects income first then spending. The first round of GDP change in the multiplier process will be equal to the smaller change in spending. [A dollar change in government purchases has the opposite impact of a dollar change in taxes. For example, an increase in government purchases increases income, spending, and GDP in the economy. In contrast, an increase in taxes lowers income, spending, and GDP in the economy. As a result, the government purchases multiplier is positive, and the tax multiplier is negative. A dollar change in government purchases will have a larger affect on GDP as compared to a dollar change in the tax multiplier. A change in government purchases affects overall spending directly. The first round GDP change in the multiplier process will be equal to this change in spending. In contrast, a change in taxes affects income first and then spending. For example, a tax cut will increase income, but not all of that income will be spent; some of it is saved. The fraction of income that is spent is the MPC times the income change. The first round GDP change in the multiplier process will be equal to this smaller change in spending. Hence, a decrease in taxes will have a smaller impact on equilibrium than would an increase in government purchases.]

Suppose the Federal Reserve purchases $10,000 of Treasury bonds from you and that you deposit the $10,000 into your checking account deposit at Bank Y. Assume that Bank Y has no excess reserves at the time you make your deposit and that the required reserve ratio is 20 percent. a. Use a T-account to show the initial effect of this transaction on Bank Y's balance sheet. b. Suppose that Bank Y makes the maximum loan they can from the funds you deposited. Use a T-account to show the initial effect on Bank Y's balance sheet from granting the loan. Also include in this T-account the transaction from question (a.). c. Now suppose that whoever took out the loan in question (b) writes a check for this amount and that the person receiving the check deposits it in Bank Z. Show the effect of these transactions on the balance sheet of Bank Y and Bank Z, after the check has been cleared. On the T-account for Bank Y, include the transactions from questions (a) and (b). d. What is the maximum increase in checking account deposits that can result from your $10,000 deposit? What is the maximum increase in the money supply? Explain.

A) Bank of Y Assets - Reserves: $10,000 Bank of Y Liabilities - Deposits: $10,000 B) Bank Y has to hold $2,000 of required reserves, leaving $8,000 of excess reserves which they loan. Bank Y increases the checking account of the borrower by $8,000. Bank of Y Assets - Reserves: $10,000 Bank of Y Assets - Loans: $8,000 Bank of Y Liabilities - Deposits: $10,000 Bank of Y Liabilities - Depositis: $8,000 C) At Bank Y, when the $8,000 check clears, reserves will fall by $8,000 and the borrower's checking account will be empty. At Bank Z, the deposit of the $8,000 check increases checking account deposits and reserves by $8,000. Bank of Y Assets - Reserves: $2,000 Bank of Y Assets - Loans: $8,000 Bank of Y Liabilities - Deposits: $10,000 Bank of Z Assets - Reserves: $8,000 Bank of Z Liabilities - Deposits: 8,000 D) The maximum increase in checking account deposits is $50,000: $10,000 times the simple deposit multiplier of , or 5. The money supply also increases by $50,000, because the original deposit of $10,000 came from a check from the Federal Reserve.

Suppose you deposit $4,000 in currency into your checking account at Bank of America. Assume that Bank of America has no excess reserves at the time you make your deposit and that the required reserve ratio is 10 percent. a. Use a T-account to show the initial effect of this transaction on Bank of America's balance sheet. b. Suppose that Bank of America makes the maximum loan they can from the funds you deposited. Use a T-account to show the initial effect on Bank of America's balance sheet from granting the loan. Also include in this T-account the transaction from question (a.). c. Now suppose that whoever took out the loan in question (b) writes a check for this amount and that the person receiving the check deposits it in Bank of Boston. Show the effect of these transactions on the balance sheet of Bank of America and Bank of Boston, after the check has been cleared. On the T-account for Bank of America, include the transactions from questions (a) and (b). d. What is the maximum increase in checking account deposits that can result from your $4,000 deposit? What is the maximum increase in the money supply? Explain.

A) Bank of America Assets - Reserves: $4,000 Bank of America Liabilities - Deposits: $4,000 B) Bank of America (Bank A) has to hold $400 of required reserves, leaving $3,600 of excess reserves which they loan. Bank of America increases the checking account of the borrower by $3,600. Bank of America Assets - Reserves: $4,000 Bank of America Assets - Loans: $3,600 Bank of America Liabilities - Deposits: $4,000 Bank of America Liabilities - Deposits: $3,600 C) At Bank of America (Bank A), when the $3,600 check clears, reserves will fall by $3,600 and the borrower's checking account will be empty. At Bank of Boston (Bank B), the deposit of the $3,600 check increases checking account deposits and reserves by $3,600. Bank of America Assets - Reserves: $400 Bank of America Assets - Loans: $3,600 Bank of America Liabilities - Deposits: $4,000 Bank of Boston Assets - Reserves: $3,600 Bank of Boston Liabilities - Deposits: $3,600 D) The max increase in checking account deposits is $40,000 - so $4,000 times the simple deposit of 10. WIth the original deposit of $4,000 came from the currency, the money supply will increase to $36,000 - $4,000. [he maximum increase in checking account deposits is $40,000: $4,000 times the simple deposit multiplier of , or 10. Given that the original deposit of $4,000 came from currency, the money supply will increase by $36,000: $40,000 minus $4,000.]

Identify each of the following as (i) part of an expansionary fiscal policy, (ii) part of a contractionary fiscal policy, or (iii) not part of fiscal policy. a. The personal income tax rate is lowered. b. Congress cuts spending on defense. c. College students are allowed to deduct tuition costs from their federal income taxes. d. The corporate income tax rate is lowered. e. The state of Nevada builds a new tollway in an attempt to expand employment and ease traffic in Las Vegas.

A) (i) B) (iii) C) (iii) D) (i) E) (iii)

Explain how each of the following events would affect the short-run aggregate supply curve. a. A decrease in the price level b. A decrease in what the price level is expected to be in the future c. A price level that is currently lower than expected d. An unexpected decrease in the price of an important raw material e. A decrease in the labor force

A) A decrease in price level would result in movement down along the short-run aggregate supply curve B) A decrease in what the price level is expected to be (in the future) would result in the short-aggregate supply curve to shift to the right C) A price level that is currently lower than expected would cause firms to decrease their prices and causing the short-run aggregate supply curve to shift to the right D) An unexpected decrease in the price of an important raw material would result in the short-run aggregate supply curve to shift to the right as well E) A decrease in the labor force would result in the short-run aggregate supply curve to shift to the left

Explain how each of the following events would affect the long-run aggregate supply curve. a. A lower price level b. A decrease in the labor force c. A decrease in the quantity of capital goods d. Technological change

A) A lower price level would result in movement along the long-run aggregate supply curve B) A decrease in the labor force would result in the long-run aggregate supply curve shift to the left C) A decrease in the quantity of capital goods would cause the long-run aggregate supply curve to shift to the left as well D) Technological change would cause the long-run aggregate supply curve to shift to the right

Refer to Figure 16-12. An increase in government purchases of $200 billion causes aggregate demand to shift ultimately from AD 1 to AD 2. Assuming a constant price level, the difference in real GDP between point A and point B will be ________ $200 billion.

Greater Than

Refer to Figure 13-2. Ceteris paribus, an increase in workers and firms adjusting to having previously overestimated the price level would be represented by a movement from

SRAS 1 to SRAS 2

Use the dynamic model of aggregate demand and supply to illustrate a situation where aggregate demand and short-run aggregate supply are both increasing from year 1 to year 2, resulting in a higher price level and higher level of real GDP at macroeconomic equilibrium in year 2.

The aggregate demand and supply model provides the overall framework for bringing economic factors together in one diagram. An increase in the price level results in a decrease in the quantity of real GDP demanded because a higher price level reduces consumption, investment, and net exports. As well as the long run economic growth is due to productivity increased over time demonstrated by a rightward shift of the aggregate supply. The vertical line representing potential GDP—the full-employment level of gross domestic product—gradually shifts to the right over time as well. In the short run, GDP, falls and rises in every economy as the economy dips into recession or expands out of recession. When an AD/AS diagram shows an equilibrium level of real GDP substantially below potential GDP. Inflation fluctuates in the short run, and higher inflation rates typically occur either during or just after economic booms. One possible trigger is if aggregate demand continues to shift to the right when the economy is already at or near potential GDP and full employment, thus pushing the macroeconomic equilibrium into the steep portion of the aggregate supply curve.

How will the purchase of $100 million of government securities by the Federal Reserve change bank reserves and total checking account deposits in the banking system as a whole? Assume that banks do not hold any excess reserves, that households and firms do not change the amount of currency they hold, and that the required reserve ratio is 20 percent.

The bank reserves will increase by $100 million if and when the seller of the bond deposits the $100 million in the checking account. Then the total checking account deposits in the banking system will increase by $500 million. As so the $100 million increase in the reserves times the simple deposit multiplier (5).

In 2008, the Treasury and Federal Reserve took action to save large financial firms such as Bear Stearns and AIG from failing. Which of the following is one reason why these measures were taken?

The bankruptcy of a large financial firm would force the firm to sell its holdings of securities, which could cause other firms that hold these securities to also fail.

Refer to Table 16-5. The economy is in the state described by the table above. Draw the dynamic aggregate demand and aggregate supply diagram to illustrate the state of the economy in year 1 and year 2, assuming that no policy is pursued. Then illustrate and explain the appropriate fiscal policy to use in this situation. Assume that the policy results in the economy producing potential GDP. Year 1 - $10.2 Trillion (Potential Real GDP) - $10.2 Trillion (Real GDP) - 100 (Price Level) Year 2 - $10.8 Trillion (Potential Real GDP) - $10.6 Trillion (Real GDP) - 103 (Price Level)

The economy starts in equilibrium at point A, at potential real GDP of $10.2 trillion and the price level of 100. W/o the policy, aggregate demand would shift from AD1 to AD2. In addition, because long-run aggregate supply shifts from LRAS1 to LRAS2, this increase in aggregate demand moves the economy to equilibrium GDP below potential GDP. The economy will be at a short-run equilibrium at point B, with real GDP of $10.6 trillion and price level 103. Increasing government purchases and or lowering taxes will shift aggregate demand to AD2. The economy will be at equilibrium at point C with real GDP of $10.8 trillion and price level at 107. The price level is higher than it would have been if the expansionary fiscal policy had not been used. [The economy begins in equilibrium at point A, at potential real GDP of $10.2 trillion and a price level of 100. Without policy, aggregate demand will shift from AD1 to AD2 (without policy). Because long-run aggregate supply shifts from LRAS1 to LRAS2, this increase in aggregate demand pushes the economy to equilibrium GDP below potential GDP. The economy will be at a short-run equilibrium at point B, with real GDP of $10.6 trillion and a price level of 103. Some firms will be operating at less than their full capacity, incomes and profits will be falling, firms will lay off workers, and the unemployment rate will rise. Increasing government purchases or lowering taxes will shift aggregate demand to AD2 (with policy). The economy will be in equilibrium at point C with real GDP of $10.8 trillion and a price level of 107. The price level is higher than it would have been if expansionary fiscal policy had not been used.]

Use the dynamic aggregate demand and aggregate supply model and start with Year 1 in a long-run macroeconomic equilibrium. For Year 2, graph aggregate demand, long-run aggregate supply, and short-run aggregate supply such that the condition of the economy will induce the president and Congress to conduct contractionary fiscal policy. Briefly explain the condition of the economy and what the president and Congress are attempting to do.

The president and Congress conduct contractionary fiscal policy to reduce inflation. In the graph below, the economy would move from point A in Year 1 to point B in Year 2 without any contractionary fiscal policy. At point B, inflation is higher than it would be if real GDP equaled potential real GDP. The president and Congress would decrease government purchases or increase taxes to slow down aggregate demand, trying to keep the economy at potential real GDP.

Use the money demand and money supply model to show the money market in equilibrium with an interest rate of 5 percent and the quantity of money of $800 billion. Suppose the Federal Reserve increases the money supply to $850 billion. At the previous equilibrium interest rate of 5 percent, will households and firms now be holding more money or less money than they want to hold, and will they be buying or selling short-term financial assets? At the new equilibrium interest rate, households and firms will desire to hold the entire $850 billion of the money supply. What causes households and firms to want to hold the additional $50 billion of the money supply?

They will be holding more money than they want to hold, so they will buy short-term financial assets. The lower interest rate at the new equilibrium decreases the opportunity cost of holding money, so households and firms desire to hold more money.

What economic impact would the closing of a nearby military base have on a town? Would people and businesses that did not directly deal with the military personnel be affected?

Well the multiplier effect would have an effect because of the closing of the military base would cause a large effect on the town. The businesses and companies that sold directly to the military people would lose sales, causing in declining profits and layoffs. With less income, the businesses and workers would buy fewer goods and services from other businesses in town which would cause a drop in the income of the owners and workers in other businesses. With less income it would also decrease the spending and the multiplier effect would spread through the town. [Through the multiplier effect, the closing of the military base would have a large effect on the town. The businesses that sold directly to the military personnel would lose sales, resulting in declining profits and layoffs. With less income, these business owners and workers would buy less goods and services from other businesses in town, which would drop the income of the owners and workers in the other businesses. With less income, they would also decrease their spending and the multiplier effect would spread through the town.]

If policymakers implement an expansionary fiscal policy but do not take into account the potential for crowding out, the new equilibrium level of GDP is likely to

be below potential GDP

To offset the effect of households and firms deciding to hold less of their money in checking account deposits and more in currency, the Federal Reserve could

buy treasury securities

Using the aggregate supply and demand model, illustrate what happens in the long run when the economy suffers a supply shock. Begin your analysis by assuming the economy has suffered the supply shock in the short run, but has not yet adjusted to it in the long run.

if the economy is at point B with the price level alike to P2 and the amount of real GDP at Y2. The economy is at a short-run equilibrium after a supply shock. The increasing rate of unemployment and falling output causes workers to accept lower wages as well as firms (accepting lower prices). Then this will shift the SRAS curve to the right as their outlook changes. Which then lowers the price level from P2 to P1 and raises real GDP from Y2 to Y1. Unemployment falls as real GDP rises back to potential GDP at Y1.

Suppose that households became mistrustful of the banking system and decide to decrease their checking account balances and increase their holdings of currency. Using the money demand and money supply model and assuming everything else is held constant, the equilibrium interest rate should

increase

The purchase of $1 million of Treasury securities by the Federal Reserve, if there is no change in the quantity of currency, will cause reserves at banks to

increase by $1 million

Refer to Figure 16-2. In the graph above, if the economy is at point A, an appropriate fiscal policy by Congress and the president would be to

increase government expenditures

From an initial long-run macroeconomic equilibrium, if the Federal Reserve anticipated that next year aggregate demand would grow significantly faster than long-run aggregate supply, then the Federal Reserve would most likely

increase income tax rates

If a person withdraws $500 from his/her savings account and puts it in his/her checking account, then M1 will ________ and M2 will ________.

increase; not change

According to the quantity theory of money, deflation will occur if the

money supply grows at a slower rate than real GDP

Refer to Table 15-2. Consider the hypothetical information in the table above for potential real GDP, real GDP, and the price level in 2016 and in 2017 if the Federal Reserve does not use monetary policy. If the Fed uses monetary policy successfully to keep real GDP at its potential level in 2017, which of the following will be higher than if the Fed had taken no action? 2016 - $18 trillion (Potential Real GDP) - $18 trillion (Real GDP) - 150 (Price Level) 2017 - $18.5 trillion (Potential Real GDP) - $18.2 trillion (Real GDP) - 152 (Price Level)

real GDP and the inflation rate

During the turmoil in the market for subprime mortgages in 2007 and 2008, the Fed increased the volume of discount loans. The goal of the Fed was to

reassure financial markets and promote financial stability

Hurricane Katrina destroyed oil and natural gas refining capacity in the Gulf of Mexico which subsequently drove up natural gas, gasoline, and heating oil prices. Three years later, once the refining capacity was restored, these prices came back down. The restoration of refining capacity should

shift the short-run aggregate supply curve to the right

Refer to Figure 15-11. In the dynamic model of AD- AS in the figure above, if the economy is at point A in year 1 and is expected to go to point B in year 2, and the Federal Reserve pursues no policy, then at point B

the economy is below full employment.

Which of the following describes what the Fed would do to pursue an expansionary monetary policy?

use open market operations to buy Treasury bills